ESG direct index investing doesn’t go far enough. Consider impact investing instead.

By Amber Miller

As we think about ESG investing’s role in financial planning and helping clients toward their life goals, it’s the latter part of this that most concerns me. If we are listening to our clients, and they are interested in values-based investing (sometimes called sustainable investing, ESG investing, SRI, etc.), then pure ESG index investing focused on environmental, social, and corporate governance issues often misses the point.

Values-based investing is personal. Each client has their own view of what’s important to them. Since most public companies do not pass ALL the ESG filters or support ALL the United Nations’ sustainable development goals, it is up to clients to determine for themselves (with our help, of course), which are the most important to them and/or how to rank them.

Does ESG investing really equal values-based investing?

Imagine Company X, which could check all three of the ESG boxes if it builds solar panels (hitting the E) manufactured locally under safe working conditions (hitting the S), and is run by a group of women who don’t earn a million times* more than the employees building the panels (hitting the G). How does that compare to Company Y that also builds solar panels, but manufactures them in China, or has only White men on its board and in leadership? Or Company Z that is an oil company, but is run by Latinx individuals? The examples are endless. How do clients and their advisors compare these and decide which to include or exclude from an investment strategy?

ESG funds, especially the large-cap options, tend to hold the biggest companies in the world, including Apple, Microsoft, Google, Amazon, Meta, and Tesla. Additionally, they often hold healthcare or pharmaceutical companies like United Health, Merck, CVS, or AstraZeneca and big banks like JPMorgan Chase, MasterCard, or Visa. These are the same companies that dominate the parallel non-ESG funds in those asset classes. So the question is whether an investor is really making much of a difference by using these ESG funds. Is there a better way?

ESG funds, in addition to using ESG filters to screen in and screen out “best/worst in class” companies, consider things like corporate promises to improve. They also consider the financials in the same way as traditional funds do. This can be a great thing! Considering the book value and expected returns of companies in a fund or portfolio is the key to generating financial returns. But select your ESG funds carefully; look at the details. Traditional (including ESG) index investing can do a good job of capturing the diversity in the markets, but individual investors don’t have a lot of control over the holdings in index funds.

Role for charitable giving

I’ve been thinking about the intersection of values-based investing strategies, charitable giving, and ways to align our values with our investing and spending.

We invest (in the traditional sense of the word) with the expectation that, with good planning and selections, our wealth will grow. We can even target specific returns with different strategies. Often, we consider charitable giving as a separate strategy to help reduce taxes or even only for the emotional “return.”

Role for impact investing

Charitable giving, by default, technically has a negative (financial) return. You give your money away and do not expect anything back. In other words, your financial “return” is often negative 100%.

What if instead of this negative return, we consider an investment that may offer a lower financial return than traditional investments but a high positive impact on the causes that you care about? “Impact investing” can complement your existing strategies. There are bond options, both local and cause-specific (see “Turn outrage into investment opportunities” in the June 2020 NAPFA Advisor). Some investments don’t promise any return at all, like investing in your local grocery store to ensure you have a local option … or one that considers their supply chain to support local or organic farmers, etc. Impact Investing can even include angel investing for those with enough capital.

Other ways to create impact include choosing where to bank. Using local banks or credit unions supports your local economy. Community development financial institutions (CDFIs, see “Aligning values and investing with CDFIs” in the Dec. 2020 NAPFA Advisor) provide access to capital for communities that don’t normally have access. A CDFI may issue a bond and use the proceeds to provide support for local child-care facilities, for example.

And beyond even these traditional cash options, consider the credit cards you use and recommend. There are affinity credit cards that support your cause of choice—and still offer points to the cardholder.

 

This is all to say that while ESG index investing has a place in an investment strategy, and arguably should be considered by anyone interested in a values-based portfolio, it’s merely one tool in your investment strategy toolbox. For most investors, ESG index funds are, at minimum, a starting point and, at best, a complement to a multifaceted approach to helping clients achieve ALL of their life goals, including the intangible ones.

*Exaggerated for effect

Impact investing challenge Often local banks and credit unions offer lower interest rates than big banks. Compare the interest you’re getting from your big bank with what you would get for switching to a local bank or credit union. Switch banks and consider that “lost” interest as a nondeductible charitable contribution to your local economy.

---

Amber Miller, CFP^®, EA, Chartered SRI Counselor, is a financial planner from Minneapolis. She works with clients virtually helping them do good with their life and their money. 

image credit: istock.com/Khanchit Khirisutchalual