ESG has become one of the most prominent topics of discussion in today’s investing community. Environmental, social and governance issues have gathered serious interest by millennial investors and large institutions over the past few years, with trillions of dollars flooding into funds and ETFs that follow the strategy. Despite all of the interest, some investors and portfolio managers are still skeptical about ESG and what it means. This is for a few reasons. A common complaint is that ESG investing is too heavily influenced by the personal ideals and preferences of particular clients. There is so much subjectivity in ratings systems, ESG scores and sustainability metrics it is easy to lose sight of the bigger picture. Others claim it is a marketing scheme used to attract progressive millennial money as they begin their savings and receive the billions of dollars in inheritances that will inevitably be transferred by baby boomers. There is also the argument that ESG investing leads to the under performance of a client’s portfolio. I believe the people in these camps, or those that dismiss ESG altogether, may need a deeper understanding of the underlying issues facing people, corporations, stakeholders and our planet and how important it is to find common ground.

I contend that ESG investing is not simply an exclusionary process that screens out fossil fuels, alcohol, firearms and tobacco as is widely thought. On the contrary, ESG is an inclusionary process where investors find companies that are leaders in their respective industries and are working to set an example that becomes the baseline of industry standards. Instead of relying on subjective biases, this process should rely on realities that are objectively true and any sensible person would agree are for the better. Is there anyone that believes men and women should not receive equal pay for equal work? Can it really be contended that diversity in the board room wouldn’t lead to a more fruitful collection of ideas? Should a CEO not be held accountable for the performance of his or her company while continuing to get paid exorbitant bonuses? Is there an excuse for a company operating overseas to use slave labor to make their products just because there are more lax labor laws? There are basic tenets of civility and morality that can be violated by the decisions corporations and people make and this inevitably affects the bottom line. There is a fiduciary duty of care and responsibility that we as advisors must take very seriously. ESG is a framework of thinking that includes all stakeholders, including clients, shareholders, communities, the environment, and supply chain and recognizes the responsibility that corporations have with the resources at their disposal.

The other argument against ESG investing is that it leads to lower returns for investors, which has been proven that it does not. However, as a fiduciary, it is our responsibility to manage not only return, but also the risk associated with it. Every advisor has access to the same fundamental data, technical charts and analyst research. If there was another layer of information that could lead to a more profitable investment on a risk-adjusted basis, why would a fiduciary actively choose not to use it in his or her investment process? For example, climate risks are now being taken under consideration by ratings agencies for bonds. Without using this information, or at least being aware of it, how can an advisor be sure he or she has measured all of the risk factors for the investment? In another example, companies that implement a strong governance structure create a framework for employees to follow that encourages them to act ethically. It would only make sense that anyone investing in a company would want this in place to reduce the risk of fraud, headlines and litigation expenses that come with a fault in a company’s processes. The point here is that ESG is an additional layer of screening that can be used to reduce the overall risk of a portfolio, whether the risks are currently identified or may present themselves down the road.

The final piece to the ESG perspective that is most often overlooked and not recognized is shareholder engagement. Fund companies have largely jumped on the “ESG bandwagon” by screening out fossil fuel and sin stocks reducing exposure in the areas that they deem fit. Although this is on the right track, there are instances where just divesting from a company may not be enough to spark the change necessary to improve its processes. For example, one may think that divesting from a fossil fuel company is enough to cause the company to make changes. However, the reality is that we live in a world that is still very dependent on fossil fuels and will be for years to come. Instead of divestiture, an individual or Institutional shareholder can use their influence to present suggestions to management that can lead to a more efficient and environmentally friendly way to conduct their business. It is in this way that we can prevent complacency on behalf of management for not only profits, but also the way they innovate to do business in a more mindful way.This is why exclusions do not need to necessarily be a part of the investment process. If a company makes a mistake it is how they respond to the adversity and make the necessary changes going forward that is most important. A perfect example is the Starbucks racial-bias scandal in 2018. After two African-American men were arrested at a Philadelphia location, CEO Kevin Johnson announced that Starbucks would close 8,000 locations for a day of racial-bias training. This is an unprecedented act of a company acknowledging a mistake and taking the necessary measures to put their best foot forward and make a change. Because of this, a divestiture from Starbucks based on a violation of “Social” criteria may not be warranted because of the way they were able to respond and become a leader taking on the issue.

The ESG Perspective is a combination of using objective truths and active shareholder engagement to make investment decisions for clients. Advisors and investors need to be aware of the funds and ETFs that are greenwashing and the ones that truly take on the issues that companies are experiencing. The term “ESG investing” may become a term of the past as more and more people adopt this framework of thinking and it becomes the standard. Regardless of anyone’s opinion, the only way we will enhance company processes, reduce risk, and improve the bottom line is by working together to ignite change.

Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc.(APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk and may result in a loss of principal. Past performance does not guarantee future results.

Securities offered through American Portfolios Financial Services, Inc.(APFS) Member FINRA /SIPC. Investment Advisory Services offered through AJF Capital Management a SEC Registered Investment Advisor which is not affiliated with APFS.