Over the past several years headlines have been rife with stories and examples on how the next generation is changing the rules for everything. Why would the investment world be any different?
As the Baby Boomer (1946 – 1964) generation ages, we will begin to witness what is being called the Great Wealth Transfer. The foundation of the ordinary investor is evolving being dominated today by Generation X and Millennials (1965 – 1996).
This wealth transition has started the rise of socially responsible themed investing strategies — also referred to as ESG investing or Impact investing.
In a study called Impact Investing: At a Tipping Point the majority of affluent Generation X (72%) and Millennials (77%) said they had made an Impact investment compared to only 30% of affluent Baby Boomer and older generations.
ESG vs. Impact Investing
While ESG investing is often used interchangeably with Impact investing, the two are not the same. Impact investing means utilizing capital funds to create positive social or environmental change. An example would be a capital investment to combat climate change or to reduce the carbon footprint by “X” units. Impact investing is characterized by a direct connection between values-based priorities and the use of investor funds.
ESG investing focuses on companies making an active effort to either limit their negative societal impact and/or deliver benefits to humanity. The Sustainability Accounting Standards Board (SASB) aims to standardize the way companies report ESG criteria to better educate investors.
An example of an ESG investment might be purchasing stock in a technology company that adapts renewable energy practices, resulting in a cost benefit and positive effect on the environment. ESG investing includes factors for environmental, social, and governance within an investment strategy.
- Environmental: Investing in companies with green initiatives such as those who vow not to use pesticides in exchange of cleaner energy alternatives for its operations.
- Social: Investing in companies who donate a percentage of its profits to the local community or companies who do not support the sale of alcohol or tobacco.
- Governance: Increasing diversity in the corporate boardroom or investing in companies who have strict guidelines on top executive compensation.
Why ESG Investing
Individuals are being more selective on where they spend their money and the underlying initiatives they support. The next generation is less concerned about acquiring the goods and services they need but more so supporting companies that have a positive impact on the world we live in today.
This trend has not only risen in popularity across consumer spending but also within investment strategy. Investors are now selecting which companies to support in their retirement portfolios. While this sounds great in theory, you may be wondering how successful this strategy is once implemented.
Could ESG really impact a company’s bottom line? This approach may allow you to align your personal values with your investments, but can ESG investing perhaps outperform the broader market?
In terms of performance ESG investing strategies should not be dismissed. In fact, industry data suggests that Impact investing can generate a similar ROI (return on investment) when compared to investments that are focused only on the optimal bottom line.
A report from Morningstar found that from 2015 – 2019, sustainable ESG funds did well during both up and down markets relative to traditional fund strategies. A more recent example was during the COVID pandemic (March 2020) showed again that ESG funds fared better.
We believe that portfolios with ESG integration may provide downside protection when markets are volatile. The growth in ESG investing is projected to increase in the post-pandemic world as investment companies are saturating the market with new products to meet investor demand.
The Bottom Line
We think you can inspire or support environmental, social, and governmental change without sacrificing investment returns or inheriting unnecessary risk. Factors such as a company’s contingency plan, bonus structure, and work environment, as well as how they treat their customers and communities, are now a core focus for many investors.
The last decade was about laying the groundwork for ESG investing through education and government regulation. We expect the next decade will be about renewed commitment and putting ESG themed investing into action. The post pandemic world will likely mean a greater emphasis on the treatment of employees and the conduct of corporate boards. We believe that ESG issues will differentiate companies to a much greater extent than they have in the past.
Several studies have identified a positive correlation between ESG integration and measures of corporate performance. These studies further suggest that investment portfolios with ESG underpinnings may provide downside protection when markets are struggling.
We believe that a greater use of ESG can improve portfolio performance and lead to a positive impact on society as the Great Wealth Transfer begins. You can think of ESG and Impact investing as a bridge between Baby Boomers and their Generational X or Millennial children who want to ensure that their actions and investments are aligned with their core values.
We forecast that as this transfer of wealth develops ESG investing could be in the center of many investment portfolios. The increased demand will probably be magnified through more government regulation and institutional platforms.
Today, top analytical software such as Morningstar Workstation, historically known for its stock/fund star ratings or leading valuation software, has incorporated a sustainability tab listing an ESG Risk Rating into its screener.
How to Get Started
Think about what social issues are important to you? What initiatives would you like to see your investments support? At Aventine Financial Group LLC, we welcome ESG Themed investing within our client portfolio strategies.
If you are interested in learning more about ESG investing opportunities or would like to discover more about Financial Planning services using a CERTIFIED FINANCIAL PLANNER™ Contact Us to schedule a call.
We look forward to helping you Plan, Protect, and Grow your net worth! Let’s work together to make the world a better and more equal place for everyone.
Frank J. Fiumecaldo, CFP
Founder & President