Perspectives & Insights Article

Environmental, Social and Governance (ESG) investing has gained popularity in recent years as both individual and institutional investors are embracing sustainable investing and integrating ESG analysis into the investment decision-making process. There is also evidence that aligning investors’ desire for return with the needs of other stakeholders, including customers, employees, and local communities, can be a winning combination. Strong oversight of ESG issues by corporate boards can help to proactively mitigate potential risks while enhancing outcomes for shareholders.

Since 1970, over 600 academic studies have evaluated ESG factors and their relationship to corporate financial performance (CFP). CFP indicators include metrics that evaluate accounting results, stock market performance, business operations, growth, and risk measures. A 2015 study¹ that looked at broad trends across these 600 studies found a strong positive relationship between ESG factors and CFP. This positive relationship implies that companies focused on managing ESG risks in their businesses also deliver strong returns for shareholders.

There are many ways an individual investor can tilt toward positive ESG factors in their portfolio. The simplest way to do this is to avoid investing in companies that do not match their values. Exclusion is straightforward to implement for individuals who have strong and specific beliefs, but presents challenges as exclusion does not address two major questions: which stocks the investor should own and how to best construct the portfolio to balance risk and return. Mutual funds offer an alternative in which investment professionals manage the portfolio’s risk/return profile. However, investors do not have transparency into the ESG rationale behind individual stock and bonds held by the fund. As an alternative to these methods, some investors are opting to invest in companies that exhibit ESG leadership relative to their peers. One can think of an analogy for ESG leadership as the driver who chooses to buy a hybrid car. While the driver needs to travel via car, they still wish to limit their impact on the environment while doing so. There are many companies, even those in controversial industries, that are pushing their customers, suppliers, and competitors to improve their ESG performance, while continuing to deliver positive results for shareholders.

D.A. Davidson is committed to providing portfolio solutions for clients who want to improve the ESG rating of their portfolio. For more information, contact a D.A. Davidson financial advisor.

¹ Gunnar Friede, Timo Busch & Alexander Bassen (2015) ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 5:4, 210-233, DOI: 10.1080/20430795.2015.1118917

Information contained herein has been obtained by sources we consider reliable, but is not guaranteed and we are not soliciting any action based upon it. Any opinions expressed are based on our interpretation of the data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice. Investors must bear in mind that inherent in investments are the risks of fluctuating prices and the uncertainties of dividends, rates of return, and yield. Investors should also remember that past performance is not necessarily an indicator of future performance and D.A. Davidson & Co. makes no guarantee, expressed or implied to future performance. D.A. Davidson & Co. is a registered broker-dealer and registered investment adviser that does not provide tax or legal advice. Investors should consult their financial and/or tax advisor before implementing any investment plan. Copyright D.A. Davidson & Co., 2018. All rights reserved. Member SIPC.