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Investors bet that ESG funds can make them money and help the planet: 'You don't have to leave your values at the door'

"People want to find ways to make a difference through their investments."

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Brooks Yardley was always reluctant to invest in the stock market, because he wasn't sure what would happen with his money and whether he'd be profiting from companies that hurt the planet.  

"How did that money that you gave [into the market] become more money later?" says Yardley, a 36-year-old occupational therapist based in Quebec, Canada. "And a lot of the times, it comes from giving it to corporations who then do things like lie and, well, destroy ecosystems."

Yardley was persuaded to buy into the stock market after he learned about ESG investing, when you invest in companies based on how they perform on environmental, social, and governance criteria, not just profits.

He started putting money into ESG funds. These are ETFs, index funds, or mutual funds — baskets of securities that diversify risk. But there's a key difference between these and ordinary investment funds: ESG funds invest in companies on the basis of financial performance as well as factors such as carbon footprint, energy efficiency, diversity, fair wages, executive pay, and corruption. 

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ESG investing has boomed in recent years due to the growing number of people who care about the environment and social justice issues, like Yardley. But as ESG investing has become trendy, it has also come under fire from those who say it does little more than help fund managers make more money.

"Sustainable investing boils down to little more than marketing hype, PR spin, and disingenuous promises from the investment community," Tariq Fancy, the former CIO of sustainable investing at BlackRock, wrote in a recent USA Today op-ed.

Experts generally agree that ESG funds merit scrutiny before you invest. "If issues are important to you and you care about them, make sure that the ESG fund is actually doing what it says it is," says Karen Wallace, director of investor education at Morningstar.

Why ESG investing is booming

Investors poured record amounts of money into ESG funds in 2020, to the tune of more than $51 billion, according to Morningstar. That's more than double the total from 2019, and represents about a quarter of all money flowing into U.S. stock and bond mutual funds last year. The number of ESG funds available also grew to more than 390 last year. 

"Black Lives Matter and Covid-19 kind of raised people's awareness of social, racial injustice. And global warming is always top of mind," Wallace says. "People want to find ways to make a difference through their investments."

ESG funds generally outperformed their non-ESG peers in 2020, Morningstar found. You can also buy individual stocks that rate well on ESG criteria, though funds are a less risky choice.  

Beyond performance, ESG investing helps people feel good about where they're putting their money. "I do think ESG investing helps make the world a better place for everyone. We're all in this together," says Sierra Wagner, a 38-year-old yoga instructor in California who invests in ESG funds.

"I'm betting on the future," she says, "that the choices I make now with my money are going to do something positive into the future."

I'm betting on the future, that the choices I make now with my money are going to do something positive.
Sierra Wagner
Yoga instructor

But some experts say that might be an illusion, that ESG investing is delaying true progress on important related issues.

"It matters very little and it creates little social impact," Fancy said in a March appearance on CNBC's "Closing Bell." "But what it is doing is creating a giant societal placebo. It's lowering the chances that we're actually going to have any kind of regulatory reform. And I think that that's irresponsible."

He went on: "There is no evidence that by buying a low carbon ETF, you're actually going to lower emissions. There is evidence that fixing the rules of society through government regulation actually can do that. Where doing it through Wall Street makes no sense. They're capital allocators and they're going to chase yield and profitability." 

In March 2021, the SEC announced the creation of a task force for investigating ESG-related misconduct.  

ESG funds are 'an investment first'

In response, other experts say ESG investing is Wall Street's way of doing what it can to contribute to what should be a multipronged fight against the world's biggest problems, like climate change. 

Regulatory reform is a must, they say, but that doesn't mean that as an individual, it's not smart to do what you can — whether that's taking public transportation instead of driving or investing in companies that are more sustainable.  

I do think ESG investing helps make the world a better place for everyone. We're all in this together.
Sierra Wagner
Yoga instructor

ESG investing is, at its core, about seeking financial returns, experts say, and that's important to remember. But you can still allocate your money to companies you believe are doing the right thing. 

"Of course it's an investment first. Of course it's the financials first," says Linda-Eling Lee, global head of ESG research at MSCI. "But it doesn't mean that you have to leave your values at the door. You really can actually also have this alignment with where you'd like to see the world be."

ESG investing involves balancing your vision for the world with your vision for your portfolio. Sometimes these are clashing interests, and that's been a source of controversy. 

Many of the best performing and most popular ESG funds hold stocks that some investors find confusing. "You might be surprised to see some oil stocks," says Wallace of Morningstar. The oil and gas industry is a major source of greenhouse emissions that cause climate change.  

You might be surprised to see some oil stocks.
Karen Wallace
Morningstar director of investor education

Yardley often doesn't agree with the holdings in many ESG funds, pointing out that the inclusion of certain pharmaceutical companies tied to the opioid crisis "really bothers me."

"There was always a few companies that I didn't like," says Florian Vanlangendonck, a 28-year-old engineer based in Belgium. "So in the end, I did not go into funds at all. I prefer to handpick my own stocks."

How to balance your ethical and financial goals

Many ESG funds include controversial names because they're designed to look like and perform like the broader market. Using what's called an ESG integrative approach, these funds have gained the most traction because they're highly diversified and less risky from a financial perspective.  

"You are basically getting similar sector and geographic exposures as you would from a broad market portfolio, but you're just holding the higher ESG-rated names in those sectors," says Lee of MSCI. "So they have tended to perform similarly or better than their benchmarks over many years."  

Funds that practically exclude whole industries due to stricter ethical criteria can be riskier because they're less diversified. Think thematic funds that focus on a specific cause, like clean water or renewable energy. There are also funds that exclude all companies with exposure to certain things, like animal testing or fossil fuels. 

"Theoretically, that means that you could gain a lot in some cycles and you could lose a lot in some cycles," Lee says.  

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It's up to you to make sure your investments align with your ethics, financial goals, and risk tolerance. "You will never be able to please 100% of the people," Josh Brown, CEO of Ritholz Wealth Management, said in a January 2020 appearance on CNBC's "ETF Edge."

"The important thing is to say, 'Look, this is where I draw my line in the sand,'" he says. "So, for example, I'm conscious of the environment but I can't have zero exposure to energy, and there's not enough market cap in solar. So I'm going to have some natural gas companies that I think have a good record on taking care of their environmental responsibilities. Then there's some people who say no oil whatsoever. You have to decide what is a livable, workable portfolio." 

Before investing in an ESG fund, experts say to research its ethical and investment objectives.

You have to decide what is a livable, workable portfolio.
Josh Brown
Ritholz Wealth Management CEO

"It's important not to judge a book by its cover," Lee says. "You really should be using ESG fund ratings tools to look underneath the hood."

Wallace concurs. "Sometimes putting in a little bit of work on the front end and then just kind of letting your portfolio — set it and forget it for years — it's worth that front-end effort," she says.

At the end of the day, ESG investments are still investments, and diversification is key.

Likewise, if your goal is to make a positive impact, it pays to diversify your good deeds. ESG investing is just one of many ways to try to make a difference in the world.   

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