ESG vs Traditional Investing

ESG vs Traditional Investing

What is ESG vs traditional investing? When my clients first asked me this question 5 years ago, I didn’t have a great answer. At the time, sustainable investing seemed like a passing fad.

But I was wrong. As I researched ESG strategies, spoke with more young investors and read the data on returns, I realized this approach has real staying power.

Integrating environmental and social impact creates better risk-adjusted returns while aligning your money to your values.

In this post, I’ll walk through the key distinctions, performance attributes and implementation trends to demonstrate why ESG is here to stay.

Integrating Social Conscience with Financial Returns

Traditional investing focuses purely on maximizing financial returns without much regard for external factors. By contrast, ESG strategies aim to incorporate environmental and social impact alongside risk and return.

Key aspects of ESG investing include:

  • Considering how companies address issues like climate change, human rights, diversity, and data security
  • Evaluating corporate governance factors such as executive pay, board diversity, and transparency
  • Investing in alignment with personal values on topics like clean energy and fair labor practices
  • Seeking to improve society while still generating competitive investment performance

In essence, ESG allows investors to apply a social conscience or set of values to investment decisions. It provides a framework to identify companies that meet high standards across material environmental, social, and governance risks and opportunities.

ESG Factors, Criteria and Reporting Frameworks

Several major ESG data providers, ratings agencies and reporting frameworks have emerged to help standardize comparisons across companies:

  • UN Sustainable Development Goals (SDGs): The UN SDGs are 17 defined targets meant to address global challenges like poverty, climate change and justice. Many companies align their ESG programs and reporting to support specific SDGs.
  • MSCI ESG Ratings: MSCI evaluates over 8,500 global companies on ESG risks and opportunities, providing letter-graded ratings from AAA to CCC.
  • FTSE Russell ESG Ratings: The FTSE Russell ESG rating methodology assesses over 4,000 global companies as exposure leaders, exposure laggards or neutral.
  • Morningstar Sustainability Rating: Morningstar provides a sustainability rating for funds based on underlying portfolio ESG risk versus peer funds.
  • B Lab: B Lab certifies companies meeting rigorous standards of social and environmental performance, accountability, and transparency as B Corporations.

Common ESG criteria evaluated across these rating systems include:

  • Environmental – GHG emissions, climate risk mitigation, water usage, waste management, biodiversity impacts
  • Social – labor practices, employee health and safety, diversity and inclusion, product safety and quality, data privacy/security, community relations and impact
  • Governance – executive pay alignment, board diversity and independence, business ethics, transparency and reporting, shareholder rights

Gaining visibility into company performance across material ESG topics through data from ratings agencies and reported metrics allows investors to better evaluate risks and opportunities.

The Investment Case for ESG Strategies

Beyond achieving positive impact, employing ESG factors in the investment process aims to improve risk-adjusted returns. Multiple studies suggest firms scoring highly on ESG metrics can generate competitive performance over the long run.

Let’s examine some of the ways ESG strategies can potentially lead to outperformance versus conventional investing approaches:

1. Mitigating Risk Through ESG Frameworks

Proponents argue integrating ESG criteria into analysis can help identify risks not captured by traditional financial metrics alone. These include:

  • Legal and Regulatory Risks – Failing to meet evolving standards on issues like emissions, labor practices or governance can result in fines, lawsuits and sanction. This legal exposure can directly impact finances.
  • Reputational Risks – Controversies around topics like environmental spills, privacy violations or unethical behavior can greatly damage corporate reputation among customers. Poor stewardship of ESG factors can pose serious business risks.

Employing ESG frameworks to monitor areas like environmental performance, labor relations and governance controls can help investors avoid companies with outsized risks in these areas.

2. Capturing Growth Through ESG Opportunities

Conversely, ESG data and insights can help identify emerging opportunities that may not be reflected in traditional valuation analysis. Examples include:

  • Firms well-positioned to capitalize on growing demand for products and services that address environmental and social challenges – such as renewable energy, electric vehicles (EVs), or organic foods.
  • Companies leading on innovations related to clean technology, healthcare access, financial inclusion and other ESG-related mega-trends.
  • Firms embracing diversity and inclusion programs to access wider talent pools, better reflect customer demographics, and boost employee satisfaction and retention.

Integrating ESG factors into research can surface these opportunity areas that forward-looking indicators like revenue growth, addressable market size and competitive positioning may miss.

3. Constructing ESG-Focused Investment Portfolios

Research suggests that companies managing ESG factors demonstrate operational excellence which translates into cash flow outperformance over the long run. This makes integrating ESG criteria a potentially useful factor in building portfolios.

Portfolio construction approaches aligned with ESG priorities include:

  • Screening investment universes for companies with high ESG ratings and positive momentum
  • Tilting portfolios towards sectors and industries with strong ESG profiles
  • Ensuring portfolio alignment with sustainability-focused themes like clean energy, responsible consumption, and financial inclusion
  • Active company engagement and proxy voting to drive improved ESG performance

This framework aims to produce a portfolio resilient against ESG-related risks and positioned to capture emerging opportunities.

Evaluating ESG Investment Performance

Critics of ESG investing argue that incorporating non-financial factors into portfolio construction may require sacrificing performance and taking on additional risk. However, research on actual strategy returns challenges this view.

Numerous studies have analyzed the performance of ESG mandates over multi-year periods. While findings vary across time periods and underlying methodology, a meta-study by NYU Stern found that ESG investing generally met or exceeded the performance of comparable traditional strategies.

Let’s examine ESG performance and risk attributes from a few perspectives:

{% include image.html images=”esg-performance.png” %}

Figure 1. Cumulative Returns of ESG Index vs S&P 500

Return Analysis

The chart above shows the MSCI USA ESG Leaders Index outperforming the S&P 500 over a 10+ year period through late 2021 with lower volatility. While exceptions occur, this directionally aligns with much of the research.

Surveying 200 studies, Deutsche Bank found a slight majority identified a positive correlation between ESG score improvements and valuation outperformance. So beyond baseline market returns, focusing on high and improving ESG scorers may improve results.

Risk and Drawdown Analysis

Bank of America research examining performance through historical market drawdowns found the MSCI USA ESG Leaders Index to be more resilient.

This reflected approximately 20% lower beta during downturns – highlighting a potential diversification benefit for ESG mandates.

Growth, Value and Quality Attributes

Research from BlackRock evaluating style-based performance suggests ESG mandates may shift based on construction approach:

  • ESG growth strategies demonstrate strong returns with higher growth attributes
  • ESG value strategies offer lower volatility and higher dividend yield factors
  • Quality and risk metrics are strong across both value and growth mandates

This indicates investors can design ESG allocations aligned to their preferred investment factors.

In total, performance data makes a reasonable case for ESG approaches to match or even exceed conventional investment strategies.

{% include tables.html images=”esg-performance-table.png” description=”Table 1. Summary of academic studies examining financial performance of ESG investing strategies.” %}

Let’s shift to evaluating how real-world ESG portfolios and products have delivered.

Case Studies: Top ESG Investment Funds

While historical performance analysis helps, evaluating actual fund returns offers further insight into how ESG approaches perform.

Mutual funds and ETFs operate as live portfolios, providing ongoing case studies into how integrating ESG criteria impacts returns across various mandates.

1. Green Century Equity Fund

Green Century Funds run focused ESG strategies like the Green Century Equity Fund, launched in 1991. This pioneering fossil fuel-free US large cap fund has delivered competitive long term performance:

10 Year Annualized Return

  • Green Century Equity Fund: 11.23%
  • S&P 500: 13.03%

While slightly trailing the S&P 500, the fund has exceeded category benchmark and peer average returns over the decade-plus period per Morningstar data. Demonstrating investors need not sacrifice performance to align portfolios with environmental priorities.

2. Parnassus Endeavor Fund

The Parnassus Endeavor Fund also adopts a fossil fuel-free responsible investment mandate. As one of the first ESG-focused funds founded in 2005, it has an extensive track record across market environments:

  • The fund has beaten its benchmark Russell 1000 Index in 8 of the past 10 years
  • It has earned a 5-star rating from Morningstar with a 10 year annualized return of 13.28%

The fund demonstrates leading ESG funds can consistently outpace the broader market over longer-term horizons.

3. Vanguard ESG ETFs

Passive investing leader Vanguard entered the ESG ETF market in 2018, providing low-cost options aligned to ESG metrics. Offerings like the Vanguard ESG US Stock ETF (ESGV) integrate environmental and social factors into index construction:

  • ESGV has attracted over $3 billion in assets since launching
  • The fund has closely tracked its benchmark Russell 3000 ESG Index
  • It carries a low 0.12% expense ratio with a current SEC yield of 1.72%

With minimal tracking error and costs, Vanguard’s fast-growing ETF confirms investors can gain indexed ESG exposure without sacrificing performance or diversification.

The returns and rapid inflows into these and other top ESG strategies confirms not only competitive returns, but growing investor demand. This leads into implementation trends.

Implementing and Growing ESG Investment Programs

Integrating ESG factors allows investors to align capital allocation with personal values and societal priorities like climate change. But practical challenges to adoption remain, including perceptions of complexity, higher costs and limited offerings.

Implementation levels continue rising rapidly, confirming these adoption barriers are falling across both institutional and individual channels.

Let’s examine some positive trends:

Rapid Growth in ESG Investment Policies

  • Over 3,200 investment managers have signed the UN-backed Principles for Responsible Investment (PRI) to incorporate ESG issues into practices
  • 75% of S&P 500 companies published corporate sustainability reports in 2021 compared to under 20% in 2011
  • Europe’s SFDR ESG reporting standard continues catalyzing transparency from financial market participants

Proliferation of ESG Products and Solutions

  • Morningstar identifies over 700 Europe-based open end funds employing ESG criteria with assets over €900 billion
  • Major asset managers like BlackRock, Vanguard, Charles Schwab, and Goldman Sachs are expanding ESG ETF lineups
  • Bloomberg tallies global ESG assets over $40 trillion across mutual funds, ETFs, pensions and insurance reserves

Growth Among Financial Advisors

  • In the US, 95% of financial advisors fielded questions on ESG investing per CNBC survey, citing rising client demand
  • Merrill Lynch incorporated ESG scores into client reports and advisor desktop tools after data showed interest doubling in two years
  • Wells Fargo aims to have $8 billion in client ESG assets by 2025 to address growing interest

This rising adoption shows interest extends well beyond niche demand. Integrating ESG factors has gone mainstream across both institutional and retail investment channels.

Key Takeaways

Despite some lingering misperceptions, adoption trends and performance data reveal ESG investing has entered the mainstream.

Not only for values alignment, but as comprehensive investment strategy delivering robust risk-adjusted returns over the long run.

Concerns around issues like greenwashing and ratings complexity persist. But transparency initiatives like B Lab certification and reporting frameworks like UN SDGs bring encouraging progress on consistent measurement.

The numbers confirm ESG and responsible investing is here to stay and set to expand in the coming years:

  • Global ESG ETF assets topped $350 billion in January 2022 per ETFGI data – nearly doubling since 2019
  • Europe could reach $35 trillion in sustainable investments by 2025 representing over 50% of total professionally managed assets according to Opimas research
  • 95% of millennials show interest in sustainable investing according to Morgan Stanley, pointing to further growth ahead

In total, the research suggests investors may no longer need to choose between values alignment and portfolio performance.

Leading asset managers have put to rest the notion that sustainable investment options can’t compete with conventional strategies.


ESG vs Traditional Investing
ESG vs Traditional Investing

What Is The Difference Between Esg Investing And Impact Investing?

The core difference between ESG investing and impact investing comes down to intentionality of social or environmental impact.

  • ESG investing integrates environmental, social, and governance factors into the investment process and portfolio construction. The primary goal remains risk-adjusted financial returns, but with added transparency on issues like climate impacts, labor practices and governance.
  • Impact investing goes a step further, actively targeting quantified positive social or environmental impact alongside financial returns. Investors intentionally allocate capital to support measurable improvements in areas like renewable energy access, affordable housing, or healthcare availability.

So while ESG investing values conscious alignment and sustainability, true impact investing pursuits concrete societal and planetary progress.

What Is The Difference Between Esg Investing And Ethical Investing?

While the terms are sometimes used synonymously, a few key distinctions exist:

  • Ethical investing focuses narrowly on aligning investments to an investor’s moral principles, often by excluding industries like tobacco, weapons or fossil fuels.
  • ESG investing takes a broader and more data-driven approach to assessing corporate behavior across a wider range of environmental, social and governance factors.
  • ESG strategies may avoid industries based on controversy risk, but more commonly tilt portfolios towards higher ESG scorers rather than rely solely on exclusionary screening.

So ESG investing incorporates ethical values while also identifying opportunities beyond only negative screens.

What Is The Difference Between Esg And Socially Responsible Investing?

Socially responsible investing (SRI) and ESG investing share similar concepts around aligning investments to societal values. In practice:

  • SRI focuses heavily on incorporating religious, political or ethical screens and guidelines into the investment process. Investors often seek to exclude objectionable industries entirely.
  • ESG strategies take a more pragmatic approach to integrating environmental, social and governance factors across sectors into analysis and portfolio construction. Rather than only negative screens, ESG tilts towards leaders demonstrating progressive sustainability practices.

As frameworks evolve, expect lines between SRI and ESG to further blur. But ESG offers a principles-based framework that extends beyond faith or values-based exclusions.

What Is The Key Difference Between Sustainable And Traditional Investment Portfolio?

The core difference lies in philosophy and process. Traditional portfolios focus solely on financial return projections and risk analysis. Sustainable portfolios add transparency around positive and negative environmental and societal impacts across underlying investments.

Key differences include:

  • Research – ESG portfolios analyze emissions profiles, controversial activities, labor and ethics track records beyond financials.
  • Security Selection – Sustainable portfolios target higher ESG-rated companies and bond issuers.
  • Stewardship – Engaging investee companies on ESG practices through proxy voting and shareholder resolutions.
  • Impact – Mapping and disclosing portfolio exposure to SDGs, green revenues, diversity metrics and other impacts.

The sustainable approach sees ESG factors as financially material and seeks to improve societal outcomes.

What Are The Pros And Cons Of ESG Investment?

Potential benefits of ESG investing include:

  • Values alignment around issues like climate change and workplace diversity
  • Mitigating downside risk via insights on controversies and litigation risks
  • Capturing growth from rising demand for sustainability-focused products and services
  • Achieving competitive long-term returns compared to traditional approaches
  • Driving positive change through corporate engagement and policy advocacy

But critics point to cons like:

  • Added complexity in analyzing ESG criteria alongside traditional financial metrics
  • Risk of overpaying for momentum around “trendy” ESG themes
  • Lagging returns possible during periods when ESG screens exclude top performers
  • Uneven transparency and ratings standards across regions and benchmarks

Ongoing growth in ESG adoption, products and standardization looks to mitigate many of these concerns over the coming years.

What Is The Difference Between Traditional And Sustainable Finance?

Traditional finance focuses narrowly on risk and return analysis of investments. Sustainable finance broadens the scope to long-term value creation for clients, society and the environment. This manifests in two key ways:

  1. Evaluating externalities and social/environmental implications of capital allocation decisions.
  2. Offering products and services that drive sustainability such as renewables financing, affordable housing and cleaner technologies.

This more comprehensive approach to finance accounts for ecological limits and social equity alongside economic efficiency.

What Is The Difference Between Traditional Financial Reporting And Sustainability Reporting?

  • Financial reporting discloses internal company financial statements, operating metrics and performance results over set time periods.
  • Sustainability reporting provides transparency into environmental, social and governance (ESG) policies, programs, targets and impacts through reports following frameworks like the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB).

While often complementary, sustainability reporting focuses externally on society-level impacts rather than strictly business profitability.

Is Sustainability Reporting The Same As ESG?

Sustainability reporting discloses performance on ESG topics but also extends into areas like:

  • Governance around sustainability
  • Ethics and compliance
  • Stakeholder engagement feedback
  • Organizational values and culture

So sustainability reporting provides richer, more qualitative insights into a company’s social and environmental commitments beyond only ESG metrics and ratings.

What Are The Different Types Of ESG Reporting?

Four common approaches to ESG reporting and disclosure include:

1. CSR Reports – Corporate social responsibility reports covering sustainability policies, initiatives and societal impact.

2. Integrated Reports – Combining sustainability impacts alongside financial results.

3. Ratings and Data – Responding to ESG data requests from ratings agencies like MSCI, ISS or Sustainalytics.

4. Framework Reporting – Guidelines-based reporting per standards like GRI, SASB, TCFD and CDP.

Firms take varied approaches aligned to industry norms and stakeholder priorities. Regulatory requirements also differ internationally around ESG disclosures.

What Is ESG Accounting And Reporting?

ESG accounting and reporting involves quantifying, disclosing and taking ownership of the environmental, social and governance footprints of internal operations and external value chains. This means:

  • Cataloging greenhouse gas emissions across Scopes 1, 2 and 3
  • Assessing diversity and pay equity across employee demographics
  • Tracking and reporting workplace safety and employee turnover
  • Monitoring controversies and incidents related to product quality, data security and ethics
  • Setting policies and targets to improve performance across material ESG topics
  • Seeking independent verification of claims through audits or certifications

Robust ESG measurement, management and disclosure helps demonstrate commitment to sustainability stakeholders.


In closing, ESG investing has clearly moved from niche to mainstream with competitive total returns. The key is embracing material sustainability factors while avoiding “greenwashing” risks.

With transparency improving via reporting standards, the data shows you can now generate solid relative returns while feeling good about driving change.

As client interest continues rising rapidly, financial advisors like myself must continue expanding ESG investment offerings and advice.

I urge everyone to evaluate this approach in their portfolio construction process to determine if sustainable investing strategies make sense for part of your own allocation.