Why ESG & Ethical Investing Differ

S&P Dow Jones Indices has been providing indexes in the environmental, social and governance (ESG) space since 1999 with the Dow Jones Sustainable Index series. This year the firm launched a new index family simply called the S&P ESG Index Series, led by the S&P 500 ESG Index. Mona Naqvi is the product manager for the company’s ESG indices, and spoke to ETF.com about what makes this suite different, and why ESG is the not the same as ethical investing. She will also be speaking at “Is There More to Core?” event sponsored by S&P Dow Jones Indices on Thursday, Oct. 24, in Chicago. 

ETF.com Why has ESG grown to be such a big part of an event like “Is There More To Core?” Is it demand? Is it education?

Mona Naqvi: It reflects what we’re seeing in the market across the board, in terms of demand from clients. There are very few conversations these days that don’t at least mention ESG. But also, in general, it fits the broader momentum within this space, where ESG is not only becoming more mainstream and more part of the conversation across all different types of clients and market participants, it’s also becoming a more mainstream strategy. This is reflected by our decision to launch a new ESG index series.

ESG is becoming more core. What used to be a satellite asset allocation is now becoming a core part of many investors’ portfolios, and traditional investment channels.

ETF.com: What can you really do to an ESG index that hasn’t been done before?

Naqvi: What we now have is a very different scenario, where ESG as a concept is a lot broader, and it relates to this idea of encompassing a broader information set in the investment process. We now have more information to create more nuanced and sophisticated ESG index methodologies than we’ve ever had before, which are more compatible with mainstream adoption, and it doesn’t require any sort of investment performance tradeoff.

That’s what makes it more compatible to main core allocation. What’s unique about this particular index series is that there's never been an ESG version of the S&P 500 that offers the same or very similar risk and return as the parent index. We’re at this watershed moment in the broader ESG landscape, where now it's possible to integrate values into core investment decisions with very little cost, whether it’s in terms of tracking error or any sort of tradeoff with returns.

ETF.com: How can an investor access this index? Through ETFs? Anything on the horizon?

Naqvi: There are already a couple of ETFs that have been launched based on the index. UBS launched one in Europe that has been very successful. Also, DWS has a product in the U.S., and we expect to see many more soon. But with any of our indices, they can be leveraged in many ways, be they mutual funds, ETFs, etc.

ETF.com: What's the easiest way for an advisor to convey both the pros and cons of ESG investing, and what are some of the first steps you’d recommend in education before you invest?

Naqvi: There is maybe some skepticism amongst the broader market around this type of investing. This comes from a very deeply held misconception that ESG investing is the same thing as values-based investing, and that it must inherently imply a tradeoff with returns. It’s almost this idea that you can't have your cake and eat it too.

But that’s a misunderstanding about what ESG really is. It’s not helped by the fact that it’s often conflated with SRI [socially responsible investing], which is something quite different. SRI has been more about ethical-based investing, being willing to deviate from the benchmark and accept high levels of risk and lower returns because it’s achieving a particular ethical goal.

ESG is simply the approach to integrating more information than is traditionally considered within traditional investment channels and company valuation. Once you look at it as the simple process of incorporating more information than we had before that is financially material, even if it isn't financial in nature, then it really shifts the nature of the conversation.

It really is about building awareness and clarifying. The simplest thing to do is to clarify that ESG is not the same thing as SRI. And once you address and tackle that head-on, then you can start to have more informed conversations with clients about what this is and isn't.

The minute people start to understand that, they're more open to having a conversation about how they might be willing to deviate from whatever traditional investment products they’ve always been drawn to, and start to consider these alternatives as being very similar in terms of risk and return, while at the same time, potentially achieving some broader social good.

ETF.com: You bring up a good point: the difference between SRI and ESG can add to the confusion.

Naqvi: I totally agree. Rather than adding more acronyms to the mix, it’s simpler and cleaner to simply say, ‘You don’t need to get technical about it.’ At the crux of the issue, it really comes down to simply explaining that ESG is not the same thing as ethics. And that’s really what it is. And it’s simply just distilling ESG as being extra financial information.

Maybe the better approach is to circumvent the acronyms and just be real in how you talk about it, rooted in something tangible that many of us can relate to, which is that the world is changing, we have more information than before. Why not incorporate it?

Drew Voros can be reached at [email protected]