Traditional socially responsible investing has been criticized for market-like exposure with a higher cost for the exclusionary screen of “sin stocks,” such as those in the tobacco, alcohol, and firearms industries. ESG is the new face of values-based investing which utilizes an inclusionary methodology to select companies exhibiting favorable traits in three distinct categories: environmental, social, and governance.
Recent studies have shown that ESG is a factor that contributes to historic stock market returns and is a component of quality within companies.
- Higher-quality companies typically provide increased stability and have the potential to outperform over time as these companies have more confident management, which may be better positioned to weather market downturns.
- ESG companies show their quality characteristics through the ability to spend more money on improving the environment, expressing care for their employees, and having diversified boards of directors who keep shareholders in mind.
- Companies focused on ESG should be better able to avoid lawsuits from financial and environmental wrongdoing.
Portfolios are focused on total return, meaning growth of value through interest, capital gains, and dividends proportionate to the investor’s risk tolerance.