I was inspired to write this post when I came across a question in the community, asking if Vanguard's LifeStrategy portfolios are ethical investments. If you were wondering too, they are not. But this post isn't about that. My curiosity about the topic led me to have a rather enlightening conversation with another community member. We talked about ethical and ESG investing and why it is important to know the difference. I've decided to share some parts of our chat here. I hope it helps you learn the difference too.
We all have values, and for some people, those values play a role when picking companies to invest in. I like to think that I am gradually becoming one of those people. My friend Sarah definitely is. When it comes to investing, she is only interested in companies whose products, policies and governance are aligned with her values. She would never knowingly invest in tobacco, gambling or mining companies, for example. Sarah is whom we'd call an ethical investor. An ethical investor negatively screens out companies whose products, policies and governance they disagree with.
Unlike ethical investing, where you exclude companies associated with negative outcomes, in ESG investing, you choose to invest in companies with high environmental, social and governance scores regardless of whether these companies are associated with negative outcomes. If you didn't catch it in my last sentence, ESG stands for Environmental, Social and Governance. It is a broad framework that fund managers use to determine whether a company can be classified as a sustainable investment. They look at factors such as how the company is protecting the climate by avoiding fossil fuels, promoting gender equality by hiring more women, building a great workplace by treating all employees well, and so on. A company with a high ESG score is considered a sustainable investment and has "high prospects" for a great future.
You probably think this makes sense, and I'm all in. But, before you dive in, it is crucial to reiterate for people looking to invest in ESG funds, that even oil majors can achieve good environmental, social and governance scores in some rankings. So, when you buy an ESG fund, be sure to look very closely at what you are buying.
That's quite personal and entirely up to you. Just remember, there are a limited number of ethical companies or companies with high ESG scores. So irrespective of the method you chose, your investment universe is limited, which could affect performance.
It depends on whom you ask. Here's what some robo-advisers have to say:
I hope this post helped you understand the difference between ethical and ESG investing. There are many other buzzwords out there - Socially Responsible Investing, Impact Investing, Positive Impact Investing, Sustainable Investing, etc. More often than not, they each refer to a variant of ESG or ethical investing. Perhaps, I can talk about them in another blog post? Let me know!
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