How To Incorporate ESG into your Investment decision-making

(Austin Business Journal) At its core, investing within an environmental, social, governance (ESG) criteria is a set of standards investors use to determine if a company operates in a sustainable and ethical manner.

While the goal of investing is to make a profit, ESG methodology digs deeper into the business practices of corporations with the dual goal of excluding some investments based on poor ESG factors and actively including those corporations with a solid ESG record.

But how does an investor incorporate ESG into their investment decision-making? It’s helpful to understand the two methodologies that govern most ESG investing.

Socially responsible investment (SRI) funds and ETFs invest in a broad array of investments and exclude companies from industries such as tobacco, weapons, alcohol, and fossil fuel. These exclusionary investments don’t attempt to promote good corporate practices, they only seek to remove the most egregious products and practices from your portfolio.

The next level of ESG funds goes a step further. These funds seek not only to weed out corporations with poor ESG scores but also to advocate for corporations that show positive changes in areas of environmental sustainability, gender and racial diversity, and treatment of all corporate stakeholders from employees to customers.

Transitioning into ESG

If the idea of ESG screening appeals to you, you will likely need to make some changes to your existing investments in order to implement it. Factors to consider with the changes are potential tax liability, changes to the underlying risk and volatility of your investments, the ability to monitor the ESG aspects of an investment, and your tolerance for higher fees.

You’ll need to understand the potential tax liability incurred from converting investments. ESG methodologies will typically lean more toward growth investments and may have elevated volatility as a result. Active ESG screening may increase turnover of securities. Also , since many ESG based funds are smaller in size and require additional monitoring, fees are typically higher. Before you make any changes, you should understand and give some weight to these areas.

Where to start?

Start with investments that you are holding at a loss in your non-retirement account. Selling these assets and replacing them with ESG funds creates an immediate tax benefit. Harvesting these tax losses and using new deposits to gradually implement ESG into your investments may not be an ideal solution, but it will allow you to avoid significant tax costs to make the change.

Because investments inside your retirement account can be repositioned without incurring tax liability, your retirement account is a natural spot to include ESG factors. Retirement accounts are also generally more appropriate for a more aggressive investment allocation. ESG methodologies will typically lean more toward growth investments and may have slightly elevated short-term volatility.

What next?

You’ll need to consider what type of ESG investing appeals to you. You may be content utilizing the first-generation exclusionary SRI if ESG is just one of many factors on which investment decisions are based. If ESG is a primary concern however, you may select funds that are more actively engaged in promoting ESG through support of certain companies and practices, proxy voting, and more intense scrutiny of corporate practices. Keep in mind not all ESG funds are alike. Some focus specifically on a single pillar of the philosophy, while others are more diversified.

ESG investing is still an evolving industry with more customized alternatives sure to come along. As an investor, its important to understand what ESG is, to understand the costs and impact associated with converting a traditional investment portfolio to an ESG-based portfolio.

Finally, it is important to manage the transition to minimize tax, maintain asset allocation, and follow existing risk tolerance parameters. If your goal is to do well and do good at the same time, incorporating ESG investing can help you accomplish that goal, providing you manage the transition wisely.

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