What Is ESG And Do ESG Stocks Outperform The Rest?

Key takeaways

• ESG stocks are shares in companies with a clear focus on sustainability and corporate citizenship
• ESG stands for “Environmental, Social, Governance,” the three things ESG companies prioritize
• Some investors prefer to focus their investments on ESG stocks for ethical reasons or a belief they will outperform the competition

Many investors want to put their money where their mouth is when it comes to promoting good corporate citizenship and environmental sustainability. However, this can be difficult since many businesses focus on profits over everything else.

One solution to this is the concept of ESG investing. We’ll discuss how ESG stocks perform and if they are a good option for investors.

To build a portfolio that focuses on ESG stocks and the growing interest in sustainable businesses, download Q.ai today.

What is an ESG stock?

An ESG stock is one that meets certain criteria for social responsibility and sustainability. ESG stands for Environmental, Social, Governance.

These companies make efforts to operate sustainably, contribute positively to their communities and ensure they act fairly when it comes to their employees and promoting diversity. They also implement transparency about their leadership and how the company is run.

Some examples of criteria that investors look for in each area include:

It’s important to note that there is no central authority that decides which companies meet ESG criteria and which do not. Each investor is left to make that decision on their own. However, many mutual fund companies offer ESG funds that focus on companies the fund manager believes meet ESG criteria.

There are also multiple third-party groups that put out ratings about a company’s ESG practices, such as MSCI.

Who should consider investing in ESG stocks?

ESG stocks are worth considering for a few different types of investors

Investors want to take positive action

Many people want to feel like they’re doing something good with their money. At the very least, some people prefer to avoid investments in things they view as immoral, such as vice stocks or companies that are polluting or damaging the environment.

ESG stocks give those investors a way to invest in businesses that align with their ethical beliefs.

Those with environmental concerns

Climate change is a growing concern, with more than two-thirds of Americans experiencing climate anxiety and about 84% of those between 16 and 25 reporting climate-related fears.

ESG investing is an option for people who want to promote companies that try to operate sustainably. Some investors also believe sustainable businesses will be better positioned for success in a future where green energy is essential.

Investors hoping for good performance potential

As with all investments, the ultimate goal is to earn a return from the stocks you buy. Many investors believe that ESG investing is an ethical strategy that is more effective at producing a positive return.

If you believe that sustainable businesses see more financial success, that can be a good reason to invest in ESG stocks.

Do ESG stocks outperform?

The jury is still out on this question. In some cases, ESG has outperformed, while in others, it has underperformed. Figuring out whether ESG stocks outperform the broader market is difficult for a few reasons.

For one, there isn’t a central authority that can decide whether a business follows ESG practices. A second is that ESG investing is still relatively new, so there is limited history to look at when comparing ESG businesses to other companies.

For example, one popular ESG ETF has produced returns of 8.01% year to date. That’s higher than the same company’s S&P 500 fund, which has returned 6.28% year to date.

However, that is only one example. A study from The Journal of Finance found that out of a pool of 20,000 mutual funds with $8 trillion in assets, those rated highly for ESG factors did not outperform those rated poorly.

There are many possible reasons for this. One argument is that companies that focus on ESG may do so at the expense of profits, leading to lower overall returns to shareholders. Another is that there is evidence that struggling businesses may turn to promoting their ESG activities as a cover for their dropping performance.

What it means for investors

Investing in ESG involves making some tough choices. You have to consider both your personal ethics and whether or not you think ESG practices will matter in the market.

If you feel like investing in ESG stocks is the proper thing to do ethically, you should certainly consider investing some of your money into businesses that match your ethical beliefs.

Similarly, if you think ESG practices will give companies a competitive edge by helping them attract socially-conscious consumers, ESG investing will help you earn a profit if that prediction comes true.

However, given the relatively limited history behind ESG investing, it’s difficult to determine how much of a competitive edge ESG practices give companies.

If you’re interested in environmentally-friendly companies, consider using Q.ai’s Clean Tech Kit. This Investment Kit focuses on businesses involved in the clean energy sector, including renewables, electric vehicles and waste reduction.

The bottom line

ESG stocks are an interesting option for investors who think that companies with strong ethical standards and good corporate social responsibility will have a competitive edge. They also appeal to investors who want to feel good about their investments.

Regardless of which type of investor you are, learning more about a company’s ESG practices can offer unique insight into how the businesses you invest in are run.

Download Q.ai today for access to AI-powered investment strategies.