Is it time to create an ESG portfolio?

The financial community has been in turmoil over ESG funds, which have shown a surprising level of strength in recent years. And now, with an elected president who supports sustainability behind the scenes, it may be time to build a larger ESG portfolio, provided you understand the risks.

A brilliant ESG outlook

It wasn’t that long ago that you didn’t have the opportunity to build a well-diversified ESG portfolio. You may have held a clean energy fund out of principle, but you also needed to hold lower rated positions on ESG factors, just to have a sufficient level of diversification.

Not so today. The ESG fund space has grown significantly in recent years to the point that it can tick all the boxes on your portfolio’s target asset allocations – including emerging markets, international developed markets, large and mid-sized national capitalizations, real estate and national and international fixed assets. Income.

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And now, with President-elect Joe Biden on his way to the White House, ESG investing is likely to continue to thrive as it benefits from a more supportive regulatory environment going forward. As a starting point, Biden is expected to join the Paris climate agreement and replenish federal initiatives to reduce greenhouse gas emissions. More than that, Biden and his running mate Kamala Harris are also likely to enact policies that go beyond the “E” in ESG, policies that also encourage responsible social and corporate governance practices.

What happens next

While analysts largely agree that ESG funds will do well under a Biden-Harris administration, there is always the question of what will happen next. Yes, Biden and Harris will likely swing the regulatory pendulum to support sustainability. But this pendulum could very well turn back in four or eight years. It could even happen at the hands of Donald Trump, who is considering running in the 2024 election.

If you are investing for the long term, it is always risky to review your portfolio based on a four year window of opportunity. Once you start making investment decisions based on who is in the White House, it becomes difficult to stop. You might find yourself in a perpetual state of trying to predict what will happen under this administration or the next. It’s not a good place to be, emotionally or financially. You will end up on a stressful roller coaster every four years, and if you act on your predictions, you could also inadvertently lower your return on your investment.

Take a measured approach

If sustainability is important to you, it’s appropriate to increase your exposure to companies with strong ESG initiatives and track records, either directly or through ESG funds, with a caveat. You don’t make these moves as a get-rich-quick strategy while Biden is president – you make them because they are right for you in the long run. You can stick to the long-term approach by remaining disciplined in choosing your ESG positions.

When selecting individual stocks, for example, assess business model, leadership team, industry dynamics, financial strength, and cash flow, in addition to ESG ratings.

To evaluate ESG funds, make sure you understand the fund selection process. The presence of ESG, clean energy or sustainability in the name of the fund doesn’t mean much. Dig in and find out how companies are selected for the portfolio. Also carefully review holdings to make sure you are not overexposed to companies like Apple, Microsoft, and Amazon. These are popular in ESG and traditional funds. Check the fund’s performance history and also look at the expense ratio. Spending on ESG funds can be high compared to traditional funds.

Finally, don’t neglect diversification. Focusing your investment on the ESG space naturally limits your diversification. This does not mean that you should invest in ExxonMobil to counter this, but just make sure that your holdings are allocated appropriately across individual companies, asset classes, and even geographies.

Focus on the long term

Building a larger ESG portfolio may be the right decision from the perspective of your worldview and values. Make sure this is the right financial decision as well by staying diverse and disciplined in your selection process. You certainly want to benefit from ESG investing in the short term, but your decisions should also make sense in the long term.