ESG Trading
ESG trading has been on the rise in recent years. Modern traders are increasingly looking to invest in companies that have a positive impact on the world. This article provides a comprehensive overview, as well as a complete guide to ESG investing. We also define a number of suitable trading strategies and list the top ESG stocks to watch in 2024.
Top ESG Trading Brokers
ESG Trading Explained
ESG stands for ‘Environmental, Social and Governance’. This form of sustainable trading considers an investment’s financial returns and impact on the world using an ESG score based on the following principles:
- Environmental – This relates to a company’s impact on the environment. This can include its carbon footprint, climate change policies and goals, renewable energy usage and even employee benefit programs i.e. cycle to work schemes.
- Social – Social factors are concerned with stakeholder relations. Examples include a company’s commitment to gender and racial equality, diversity and inclusion programs, community development, charity work and ethical supply chain sourcing.
- Governance – Governance, or corporate governance, relates to a company’s board and management team. Issues range from reasonable executive compensation, protection of shareholder rights, the diversity of directors, plus litigation history and relationships with regulatory bodies.
History Of ESG Trading
Before the boom of socially responsible investing (SRI) and ethical investing, many traders took on The Shareholder Value Theory, popularised by Milton Friedman. This gave the view that a company’s only responsibility is to maximise financial returns for shareholders that hold stock. In turn, companies focused on short-term profits above other factors, such as their impact on the environment.
However, the SRI timeline really started to gain traction in the 1960s. In light of the Vietnam War, protesters demanded that university endowment funds stop investing in defence contractors. In the 1980s, investors pulled their money out of companies with operations in South Africa. This was a bid to end the racist apartheid system at the time. This decision led to economic instability and contributed to the eventual collapse of the apartheid.
Nowadays, the approach of negatively screening companies has evolved into ESG investing, which encompasses the three factors listed above to enhance traditional financial analysis. Modern investors are becoming more conscious of the price society has to pay for short-term shareholder value. Many are seeing the value and inherent goodness of ESG trading.
Benefits Of ESG Trading
Aside from ensuring your investment choices align with your personal values, beliefs and priorities, evidence shows that ESG funds can offer similar and even higher financial returns while still balancing risk.
A 2019 white paper report by Morgan Stanley compared sustainable funds with traditional funds from 2004 to 2018. The data found that the total returns of sustainable mutual funds and ETFs were similar to traditional funds. The JUST U.S. Large Cap Diversified Index tracked the performance of companies with high ESG scores and showed a 15.94% annual return vs a 14.76% return on traditional funds.
The same Morgan Stanley study showed statistics to prove sustainable funds consistently have a lower risk rating than traditional funds, regardless of their asset class. In fact, with new challenges come new opportunities. ESG funds were more resilient during the COVID-19 pandemic, where other assets struggled. According to a recent analysis by Morningstar, 66% of ESG funds (24/26) outperformed traditional funds during COVID-19.
Evaluating ESG Stocks
An ESG score is assigned to an investment based on environmental, social and governance criteria. Today, many mutual funds, brokerage firms and robo-advisors offer products with ESG ratings. However, investment firms use varying methodologies and indicators, meaning there is no universal authority on ESG scores. Ratings are often determined by analysts who identify issues faced by a particular industry. Alternatively, data can be collected from company disclosures or NGO databases.
For example, the DowJones Sustainability Index obtains data from companies through self-reported industry-specific questionnaires. Additionally, MSCI ESG Research is one of the largest independent providers of ESG ratings. For each ESG score, it is rated on a scale from CCC (laggard) to BBB (average) to AAA (leader). Morningstar is another leading provider of ESG ratings, analysing 20,000+ ETFs.
Top 5 ESG Stocks To Watch In 2024
The following list is an outlook of promising ESG trading stocks to watch in 2024:
1. American Express
American Express has a market value of $116.6 billion and has an MSCI ESG rating of AA. Analysts are particularly impressed with the credit card company’s long-term growth prospects. Wall Street expects an average annual EPS growth of more than 40% over the next three to five years. American Express excels in corporate governance, human capital development, privacy and data security, plus carbon emissions.
2. Microsoft
Microsoft is one of a handful of companies to receive the highest ESG rating of AAA from MSCI ESG Research. The software and cloud computing company is worth $1.9 trillion and stands out for its corporate governance and investment in clean technology. Analysts at S&P Global Market Intelligence expect Microsoft to produce an average annual EPS growth of 14.1% in the next three to five years.
3. Home Depot
As the leading home improvement retailer in the US, the COVID-19 pandemic had a positive impact on Home Depot, with many of its consumers stuck inside. Home Depot has maintained a good MSCI ESG rating of AA for four consecutive years. The company stands out for its attention to chemical safety and production carbon footprint. Home Depot is valued at $348.4 billion with analysts predicting the company to generate an average annual EPS growth of 8.2% over the next three to five years.
4. 3M
3M is another company to receive the coveted MSCI ESG score of AAA, which it’s held for five consecutive years. However, the Wall Street Journal is not as confident in the stock, with some S&P analysts categorising 3M as a hold. Nonetheless, 3M has pledged to invest $1 billion toward achieving new water and climate goals. 3M is also an industry leader on issues of corporate governance, toxic emissions and waste while providing opportunities in clean tech. The company is valued at $114.9 billion.
5. Salesforce
Salesforce excels in human capital development and data security and was awarded an AA ESG rating from MSCI. It has committed 1 million employee hours to the United Nations Sustainable Development Goals. The CRM company has also joined the UN Global Compact, which is a platform for firms to align with responsible business practices. Salesforce has a market value of $209.1 billion.
Note, the list above should not be considered financial advice. Always do your own research and due diligence when ESG trading.
ESG Trading Platforms
There are several day trading brokers that make ESG investing straightforward. IG is one of the best ESG trading providers. They rank suitable stocks and offer free training so you can get up to speed with ESG trading basics with volume data defined and risk management strategies explained.
Interactive Brokers is another popular ESG trading platform. The company used an advanced market scanner and published ESG ratings on 6,000+ stocks. With such a broad range of products and finance options, it’s easy to start ESG trading with stocks that meet your criteria.
Other popular ESG investing brokerages include Blackrock, Vanguard, Fidelity, UBS Global, Nuveen, Hargreaves Lansdown and Endowus.
ESG Trading Strategies
Socially Responsible Investing
SRI frameworks use negative screening to eliminate companies and industries that don’t align with an investor’s value criteria. For example, an ESG investor could exclude weapons, tobacco, alcohol, carbon or specific commodities. Instead, they could start trading shares in healthcare companies, such as Aviva or environmentally-conscious real estate firms.
Quantitative Analysis
This form of ESG trading involves quantitative equity investing using non-financial ESG information i.e. environmental, social and governance data. ESG quant funds rely on data gathered from corporate sustainability reports or external providers. The aim is to invest in sustainable companies that are better positioned for future stock price performance.
Level Systems
This ESG trading technique is based on the prediction that short-term returns from high-scoring ESG stocks won’t be fruitful, but that profits will come in the long run. Thus, this strategy advises going long on stocks with high ESG scores and going short on stocks with low ESG scores.
Factor Momentum
This system takes a view that companies who have greatly improved their ESG score will outperform competitors. Similar to the strategy above, financial returns are most apparent in the long term. Thus, traders should focus on companies with a significant upswing in recent ESG ratings.
How To Start ESG Trading
There aren’t many standardised rules on ESG criteria. Instead, organisations and individuals often create their own guidelines. As a result, look for a framework that aligns with your own values and objectives. A good place to start is reading a company’s sustainability initiatives, annual reports and news headlines. You can then pick stocks that follow ESG principles.
Of course, this method can take time. Therefore, you could choose to invest via robo-advisers, which are digital platforms that automate, build and manage portfolios based on your preferences and goals. This is also a much cheaper option than in-person advisors or fund managers.
Once you’ve signed up to a broker, you can start building your ESG trading portfolio. There are typically two kinds of investment vehicles; individual stocks and mutual funds. You can invest in individual stocks if you believe in a company’s future performance. Of course, researching and choosing individual stocks can take a while. On the other hand, mutual funds can build out and diversify your holdings rapidly. Some mutual funds allow you to focus on a particular issue i.e. renewable energy or ethical sourcing. This allows you to personalise your portfolio’s area of impact. If your broker offers a mutual fund screening tool, you can utilise it to compare ESG ratings.
Final Word On ESG Trading
ESG trading is on the rise. This is driven partly by the growing body of evidence to show that returns from ESG stocks can outperform traditional shares and products. While guidelines and ratings are still being developed, many top brokers now list their ESG-friendly products and assign their own ratings.
FAQ
What Does ESG Investing Mean?
The definition of ESG investing simply means trading in products that consider three pillars; Environment, Social and Governance. This investing strategy screens a company’s practices and policies within these three themes. Traders will want to invest in companies with high ESG scores as it signals a positive impact, which can mean good financial returns.
What Is The Difference Between ESG Vs SRI Vs Impact Investing?
ESG investing has a set criterion, which looks at a company’s environmental, social and governance practices while also using more traditional financial measures to enhance analysis. Socially responsible investing involves negatively screening companies or excluding certain investments based on personal ethical criteria. Impact investing is focused on generating specific social or environmental outcomes. This is where investments are put into market segments dedicated to solving certain issues.
How Can I Optimise My Impact With ESG Investing?
By practising ESG trading, you are making a positive impact through your investments. ESG trading encourages companies to focus on stakeholder issues and to ensure good practices when operating in the environment and communities around them.
Is ESG Investing A Fad?
ESG investing is becoming more mainstream and has grown into a trillion-dollar market. Therefore, it’s safe to say that it is not a fad or a bubble waiting to pop. With that said, ESG trading is much more popular in the US compared to other regions like Europe or Asia.
Does The FCA Permit ESG Investing In The UK?
Currently, the FCA is examining the role and transparency of ESG score providers to tighten regulation and protect sustainable investors. This is because each company has a discrepancy in ESG indicators, with no official authority on how ratings are established.
How Do I Learn About ESG Investing?
It is normal to have lots of questions about ESG investing. Nonetheless, you don’t need a formal education to get involved. There are many sources available to help you with the basics. You can watch videos, conferences, webinars, take up training courses, listen to podcasts, read books and literature reviews. Furthermore, many news articles from The Wall Street Journal, Bloomberg, Yahoo Finance, The Economist, New York Times and FT write about practices, progress and challenges when ESG investing.