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One of the best parts about living in the Great Lake States, and previously New England, is autumn. It really doesn’t get much better than this time of year up here. Part of the joy of the season is taking advantage of all the outdoor activities and hiking available in this neck of the woods.
On a recent trek through Mohican State Park, I began waxing poetic about the woods and how to protect them, feeling bad about my overweight position in “evil” energy stocks via the Vanguard Energy ETF (VDE). Basically, I experienced all the standard tree-hugging feelings that comes along with unplugging and spending time away from civilization. Aside from the impression of guilt and a quick donation to the Nature Conservancy, I was left feeling like I could do more.
I began looking into ways to potentially align my morals with those of my portfolio and realized we all should take the trek into the forest and have the same epiphany.
While it might seem like hippy mumbo jumbo, investors may want to consider adding a touch of ESG-style investing into their portfolios. ESG stands for environmental, social, and governance investing. It also goes by “socially responsible investing.” The idea is that investors, or the managers who they hire to run their portfolios, screen for various ESG factors when selecting investments. ESG screens can include everything from resource management and pollution prevention to labor and human rights issues.
The real gist is that these ESG screens are only meant for investing in firms that have desirable social or ethical practices. And it seems that the technique is finally beginning to take off, in both adoption and returns.
Back in the 1970s and 1980s when the Earth Day movement was first gaining traction, early ESG screens were often nothing more than removing certain “unwanted” sectors from the broad market. The unfortunate thing is that many of those unwanted sectors, like guns, tobacco, big oil, booze and gambling, have traditionally been some of the market’s best performers. Needless to say, old-style ESG has historically underperformed the broader market by a lot.
But today it’s a different matter altogether.
That’s because a wide range of firms, from boring industrials to the highest technology companies, now think about ESG when designing products and policies. For example, firms like Weyerhaeuser (WY ), which cuts down trees for a living, are making their way into sustainability and SRI/ESG indexes based on a host of other factors. The opportunity set is much greater for success.
Second, that ESG success is being pushed on firms who potentially aren’t making the grade. Two of California’s largest pension funds, CalPERs and CalSTERs, have made environmental, social and governance issues a cornerstone of their investment processes. But the two pension fund giants have taken it beyond just picking SRI/ESG stocks, they have begun to actively engage firms via shareholder activism to change how they operate within an ESG framework.
CalPERs and CalSTERs aren’t alone. Plenty of other pension funds, insurance funds, and individual investors have followed suit. The world’s largest asset manager BlackRock (BLK ) recently launched a new fund designed to capture ESG metrics. At the end of 2014, more than $6.2 trillion – with a T- has flown into ESG/SRI investments.
The combination of a bigger opportunity set plus actively influencing firms to follow the ESG rules have resulted in better returns. Goldman Sachs data shows that firms who are leaders in SRI/ESG metrics are leading in terms of stock performance. According to the vampire squid, ESG stocks are outperforming rivals by an average of 25% over the long term. This echoes similar research by Deutsche Bank, who found that stocks with ESG metrics now outperform those without them on total returns 89% of the time.
At the end of the day, ESG investing is finally delivering what every investor wants: market-beating, risk-adjusted performance over the long term. And it’s making those returns by doing some good.
The move now is for you to go take your own walk in the woods, or to a lake, and have your own ESG epiphany. You don’t have to get rid of your big bad energy stocks just yet, I’m not, but it might move you to at least consider some ESG muscle for your portfolio. After all, it’s no longer about granola, Birkenstock sandals and patchouli. It’s about making some serious money.
Find a list of socially responsible ETF’s here.
Disclosure: Author is Long WY and VDE.
Image courtesy of num_skyman at FreeDigitalPhotos.net