How investors can use ESG metrics as great risk management tools

Investors have become more discerning with the shares they add to their portfolios. Although the stock market is still unpredictable, they have begun using other metrics to make their investment money well worth it in the long run. Brokers and investors now consider shares of companies that delve into social causes. Socially responsible investing emerged from this trend, and it seems like it can help investors bag stable shares as well.

Nuveen retirement and ETF solutions head Martin Kremenstein recently sat down with Business Insider and shared what he believes are the best advantages one can get through socially responsible investing.

He started with giving his own definition of environmental, social and governance (ESG) metrics. He said ESG “is a framework for analyzing companies and really assessing how well they compare to their peers in terms of performance against these metrics.”

In the history of responsible investing, brokers and investors had to sacrifice market performance. It was in the past though as Kremenstein believes that using the ESG framework will steer investors away from companies with bad practices, therefore allowing them to avoid poor additions to their portfolios as well.

He used the Equifax scandal as an example. Once the data privacy and security issues began plaguing the company, its stock began to plummet by a huge margin. In a more recent example of bad practices being exposed, Seeking Alpha reported that Facebook’s stock was down by 20 percent early in April as a result of Cambridge Analytica scandal.

According to Kremenstein, Facebook wasn’t a part of Nuveen’s NuShares ESG Large-Cap Growth ETF in 2016. Even before the Cambridge Analytica controversy erupted, Nuveen already gave Facebook poor ESG ratings because of privacy issues.

Becoming a socially responsible investor is also not as expensive as people think. Kremenstein said that their ETFs are priced properly. He added that through their ESG ETF suite, investors can support companies aligned with their beliefs without having to shell out excessive sums of money.

ESG scores can be used as excellent risk management tools. According to a recent report by MSCI, companies with ESG ratings have little chances of experiencing a catastrophic drop in share price that could stem from an incident or a scandal.

The ESG rating is not as complicated as it seems as well, and investors can really make the most of their money by relying on these scores.

Investors can use the ESG metrics to help them select the right companies for their portfolios. (Source)

Understanding ESG and how to use it properly

To fully understand the metrics, it is crucial to first measure each aspect of it. Under the environmental (E) aspect, companies are measured in terms of how they use sources like water and energy around them. This also includes waste management and any other activities that would have effects on the environment. Generally, companies can score high in E if they also show concern for the environment.

The social (S) aspect will determine how companies treat their clients and employees. It also takes into account other aspects of management in the workforce. As for governance (G), it will be based on the overall leadership and corporate structure in a company. All in all, ESG can measure a company’s overall impact on society.

Kremenstein added that ESG is a good measurement system to see if one company is doing better than the other. This could be put to good use when choosing between two leading companies in a certain sector, thus letting the investor support the certified leader in a specific industry.

However, before using the ESG scoring system, Kremenstein suggested that people should first define what is good for them. Then, they should look into how ESG providers measure a company first to see if it aligns with their beliefs. This way, they can maximize the good decisions they make when the time comes to finally invest in a share.

Socially responsible investing has become a big trend in recent years. Now that it is known to be a fairly decent risk management tool, more investors could jump on the bandwagon and trail behind companies the ESG metric system considers as good. However, if they really want to guarantee that they are investing in a good company, it’s best to do more research instead of solely relying on the said metrics.

(Featured image via DepositPhotos)