ESG Stocks - is it better?
Understanding ESG stocks and their perks
ESG has been word of mouth over recent years. Companies are seeking to abide by the global movement for better Environmental, Social and Global goals which would not just bring benefit to humanity as a whole, but to the companies as well.
Here, we will discuss what it means for a company to be listed as ESG stock, how are they assessed and what benefit would it bring to the companies and their shareholders
ESG stocks refer to stocks of companies that have attained a certain level of compliance with ESG benchmarks, many of which can be found within these companies’ annual reports themselves – apart from external evaluation by any third-party institutions.
Speaking of third-party institutions, it is important to note that there is no universally recognized set of lists on which companies or activities are considered ESG-compliant. What happens is that there are many institutions that set their own criteria over what degree of activities, products, and policies amount to an ESG-friendly policy.
There are many types of indexes that you can look into, each with its own set of rules and companies that falls within their list. Among these indexes are:
- S&P 500 ESG Index
- Nasdaq-100 ESG Index
- MSCI USA Extended ESG Focus Index
- FTSE4Good Index
Note: there are many branches of indices under the indices mentioned above, each with its own focus on certain issues, be it on climate action, social betterment, or governance best practices.
There are pros and cons to using this decentralized accreditation method. On the brighter side, if a certain company fails to be listed under one accreditation method, it can try to be listed under the others.
For example, the S&P 500 ESG Index put a precondition that to be listed under the ESG category, a company must not be involved in the tobacco production business. Thus, despite how green a tobacco company can try to be, how socially aware and active, or how transparent their governance is – they will still not be able to bear the ESG flag. However, they can still try to score ESG points through some other methods of evaluation.
The FTSE4Good US Select Index also have similar, perhaps stricter rules, where apart from tobacco, it also excludes businesses with activities such as adult entertainment, alcohol, gambling, fossil fuel and even civilian firearms (S&P 500 ESG Index only excludes controversial weapon).
Even if the company cannot be listed in these indices, it can still provide its own ESG report which investors can access and evaluate on an individual basis.
On the other hand, the Dow Jones Sustainability Indices which is launched in 1991 tracks the performance of the top 10% in the S&P Global Broad Market Index based on their long-term ESG criteria. This evaluation based on a set of indices is handled by S&P Dow Jones and RobecoSAM.
This method has received criticism over its evaluation method which is claimed to enable the “greenwashing” of certain stocks. However, the issue lies within its single-value scoring mechanism, whereby a company is given a total score out of its aggregate scores in many different aspects of ESG concern.
For example, Company XYZ sucks at keeping mother nature happy, but they are extremely glorious when it comes to governance and societal concerns. Their score in terms of environmental aspect may be a bit low, but their other scores may be cosmically high, that they still manage to earn the ESG label.
So, what we’re trying to say is – some indices’ methods may suit you, and some may not. What good a decentralized evaluating mechanism provides is that you as an investor can choose which method suits your value. Of course, you’ll have to keep yourselves familiar with the different indices and their method of evaluation.
The downside of this decentralized method of evaluation is that there are no streamlined criteria over what stocks are considered ESG stocks. Thus, it can be quite confusing if you are seeking to contribute to mother nature, for example, but a certain stock may still be under the ESG label despite not having that much in terms of environmental contribution.
Say, you’re very keen on climate change, and you seek to change the course of the world by investing your hard-earned dollars into an ESG company. While browsing, you apparently saw an energy company which claims to be ESG-approved. Now, that’s a change of course for the better, isn’t it?
As you pour your hard-earned money into the said company, only then you started to realize that this company is scraping off every last bit of mother nature’s living soul, but how? This is where the lack of a centralized evaluation mechanism sucks. They simply look for evaluation mechanisms that would make them look good!
Are all ESG stocks environmentally friendly?
Relatively speaking, yes. All ESG stocks will have to fulfil a certain level of environmental friendliness, but not all ESG stocks are created the same.
As we mentioned, not all ESG lists are created equal. Some may be more rigorous in one aspect than others. For example, the S&P 500 ESG Index has its own environmental criteria, but if you are seeking to invest in a rigorously climate-aware stock, you may want to have a look at the S&P 500 Net Zero 2050 Paris-Aligned ESG Index instead.
The main comparison between S&P 500 ESG Index and S&P 500 Net Zero 2050 Paris-Aligned ESG Index is that both have their own environmental/climate criteria. However, the latter has stricter criteria in terms of climate-risk policies. Thus, you can say that the companies that are listed under the Net Zero 2050 Paris Aligned index are the ones that may be trying to abide by the gist of the Paris climate agreement and 2050 Net Zero carbon resolution.
In a nutshell, not all stocks earn their ESG badge by focusing their effort on becoming environmentally friendly. If you want to invest in something that suits your values, it is better that you conduct your own research into these ESG stocks, specifically looking for the reasons that these stocks are put under the ESG list.
Are ESG stocks better?
Well, that depends on where you stand. Do you mean better in terms of the environment, society, governance aspect, or in terms of its profitability?
Well, if you’re seeking “better” in terms of ESG goals, the general consensus is that a little effort is better than none. Despite having no universally accepted criteria of what amounts to a better ESG practice, having these companies follow a certain benchmarking system definitely does help in terms of moving forward from the status quo.
Well, all of that sounds promising, but the ultimate investment goal to many is the ability to make money. The honest question is, can you make money while trying to keep the earth habitable over the centuries to come?
Now, there are two key factors that you may want to consider, first, whether the stocks you’re investing in themselves are profitable since ESG stocks are just normal stocks that now have a ‘green label’ on them.
For example, you’re purchasing Apple (NASDAQ: AAPL) which is one of the stocks with the most weight on the S&P 500 ESG index. This Apple stock is the same Apple stock that everyone else buys without even thinking about its ESG–compliance, but it is ESG-approved.
One way or another, ESG or not, the stocks will remain stocks regardless of their status. However, if we are to isolate all the ESG stocks into one particular index, like the S&P 500 ESG Index, are these groups of ESG stocks profitable?
Based on S&P United States LargeMidCap ESG Index 2022 performance report, its annualized net total return for the period of 1 year is at -19.21%, but it moves upward to 8.3% in 3 years, 10% in 5 years, and 12.23% in 10 years.
Apart from the returns, these ESG Indexes are seen to closely follow their benchmarks, whereby S&P 50 ESG Index closely follows S&P 500 Index, and the FTSE4Good US Select Index closely follows its FTSE USA counterpart.
However, that is if we are talking about indices – the macro-level of it. If you are looking at one particular stock that just earned its ESG badge, the question would be whether an ESG-friendly label would put a company in a better place financially.
How ESG stocks gain the upper hand
Green stocks are raking up demands given their security when facing ESG-related risks, such as climate risks. How it applies to the realm of demand is that given the current global climate landscape, companies are susceptible to not just the climate catastrophe itself, but the policies that ensue which put many non-ESG companies susceptible to events like tariff hikes, tightening rules and scrutiny from public officials.
As non-green stocks turn riskier to ESG-related events, turning to ESG stocks seems like a good hedge to many, thus driving demands for green stocks.
Apart from that, ESG companies also earn marketing boost when these companies are listed in the ESG list. To put it simply, these companies will appear in the exchange that they are in just like any other companies, but when investors search for ESG stocks, the same stocks will appear there – some also gain exposure from being in a Top 100, Top 10 or Top 5 ESG stocks list. This would definitely drive up their demands.
In some places, the officials also provide a list of companies that meet certain ESG requirements, say, their products are reliant on renewable energy, or sustainable raw materials. These products will then be published in a list by the official bodies, which would then give them more exposure to the market.
Some ESG companies also obtain their green badge by optimizing their use of resources, or by using resources that are sustainable. This optimization is good news for both the company and investors since better-optimized resources would usually mean that the cost can be used to expand the business.
All in all, each stock performs individually. You can’t simply say that an ESG stock will always make more money than its non-ESG counterparts. Nonetheless, there are many advantages which ESG stocks enjoy compared to non-ESG ones, which in return provide them with better prospects of growth.
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