By Brian Walsh, Jr., CFP
In a previous article for Retirement Daily, I outlined the many factors driving increased demand for environmental, social and governance (ESG) investment options. Between outperformance and a more favorable regulatory environment, there are several reasons why retirees and pre-retirees should implement ESG into their investment strategy.
In this follow-up article, I elaborate on how and where to include these investments in a retirement portfolio as well as tips on evaluating ESG funds.
Let’s talk allocation
Of course, each individual’s asset allocation depends on their unique needs and goals. However, when compiling an ESG portfolio, we tend not to differentiate between retirees and pre-retirees. In other words, ESG should be the core of any investment strategy whether you are in or approaching retirement. ESG funds are proven to include quality companies with sound balance sheets which make them a fit for investors of all ages.
The next question, however, is how much? If the core of a portfolio is around 35% U.S. large cap stocks, at least 20% of that should be ESG-focused. That’s because companies implementing ESG policies and practices tend to have the cash flow to do so and also pay dividends to investors. If 20% sounds like too much, investors should consider a 10-15% allocation at a minimum.
Retirees should consider attributing 70-80% of their portfolio allocations to ESG-focused investments. With retirement averaging 25-30 years, retirees need to be cognizant of the trends that will buoy their portfolios for the long-term, and ESG is one of them.
What is the best way to access ESG investments? In my first article, I recommend swapping a standard S&P 500 index fund with a large-cap ESG exchange-traded fund (ETF), such as the iShares ESG Aware MSCI USA ETF (ESGU).
ESG had historically been a relatively expensive theme to incorporate into a portfolio until the inception and rapid growth of ETFs. Through ETFs, investors can get broad-based exposure to ESG at a much lower cost and in a more liquid, nimble and tax-efficient manner. Several ESG-focused ETFs exist in the marketplace via well-known issuers such as BlackRock and Vanguard.
Investors should also consider international ESG exposure. More and more international companies and indexes have stronger, more aggressive ESG laws and policies — particularly the European Union. As such, investors might consider a 15-20% allocation to ESG in the international and emerging markets portion of their portfolios.
ETFs aren’t the only option when it comes to ESG access. Mutual funds are also on the table. An option for investors who prefer mutual funds over ETFs could be the Pax Sustainable Allocation Fund (PAXIX). Though this fund has relatively high fees, it solely focuses on sustainable investing and is a good option with an active, ESG-focused manager.
Individual stock picking is another avenue investors can explore. As an advisor, I hold individual stocks in my own portfolio, but the core is ETFs and indexes. That said, individual stock pickers interested in ESG should be looking at sectors of the market that haven’t been fully disrupted.
For instance, the health care, industrial and materials sectors are moving more toward sustainability in the way products are developed and distributed. These sectors of the marketplace have over time polluted our industries and are now looking for ways to reduce their footprint. Individual investors should look into areas like carbon capture and biotech.
The idea here is to find smaller companies in the ESG space that have the potential to grow. It could be more difficult to break into and see substantial gains from ESG in the technology industry, for instance. If you’re looking for individual stock exposure, do the right research, select strategic sectors and it could turn out very well for you down the line.
Evaluating ESG funds
The growing demand for sustainable investments has exploded, which has also forced companies and funds to falsely demonstrate “eco-friendly” initiatives. This practice is known as greenwashing — sharing misleading information to make a company or investment appear more environmentally focused than it actually is.
It is important to be mindful of these tactics and avoid such companies and indexes. Advisors and financial professionals tend to have greater access to platforms and tools that help scan companies for certain ESG criteria. For example, we have clients who are passionate about social justice issues and want their portfolios to reflect that. So, we created an ETF portfolio through Canvas, a platform that can screen for companies working toward social justice. If a company does not have policies in place supporting social justice, they are out of the portfolio.
These platforms help advisors build quality and thorough ESG portfolios. As for the everyday investor, it can be more challenging to ensure your portfolio is free of false sustainability claims, but not impossible.
For the individual investor, it starts with identifying which ESG component you would like to focus on. From there, I would recommend reviewing fact sheets of the well-known ESG funds to determine the holdings, sectors and asset classes you’re interested in. Researching those specific holdings and forming your own opinions is crucial here as well. There are also sustainability rating services available for purchase that could help individual investors build an ESG portfolio — Morningstar is a good place to start.
The beauty of ESG is that you can really immerse yourself into your investments and truly put your money where your values are. However, ESG investments do not need to be siloed into any one factor — environmental, social or governance.
That said, governance is a good gauge of a company’s stance on ESG as a whole because those that score below average on sound governance policies have been proven to be more susceptible to mismanagement. Companies that incorporate diversity into their workforce invite greater, more inclusive decisions on policies and processes. In my view, when companies have strong corporate governance, their social and environmental stances tend to fall in line as well.
Retirees and investors of all ages cannot ignore the growing investment opportunities in the ESG space. Corporations can play a critical role in driving positive change and we are likely to see a shift in how investor dollars are allocated moving forward, with ESG set to benefit. If you are interested in incorporating ESG into your portfolio, speak with your advisor or conduct independent research to ensure it aligns with your financial goals.
About the author: Brian Walsh, Jr., CFP®
Brian Walsh Jr., CFP®, is a Senior Financial Advisor at Walsh & Nicholson Financial Group, headquartered in Wayne, Pennsylvania. Prior to joining Walsh & Nicholson, Brian served as a Senior Vice President of Investments at Lincoln Financial Group. He holds the esteemed Certified Financial Fiduciary (CFF) designation and is a Certified Fund Specialist (CFS). Brian also holds Series 7, 6, 63, 65, Life, and Health Insurance Licenses.
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