Three alphabets were all the rage a few years ago when it came to stocks and investing: ESG.

An abbreviation for ‘environmental, social and corporate governance,’ ESG investors seek to align their portfolios with positive ESG principles while earning investment returns. ESG investing has its fair share of critics, with some viewing it as a trend that will eventually lose steam or that it is a form of greenwashing. Greenwashing refers to acts by firms that mislead the public about the environmental benefits of a product or practice, by making false or misleading statements. However, despite the critics, we believe that ESG investing is here to stay.

Not only has ESG investing grown exponentially since around 2020, but its trajectory is also set to rise, with management consulting firm McKinsey & Co estimating that the ESG-related investing could reach US$9 trillion to US$12 trillion in annual investments by 2030.

The Tech factor

So, now you know that ESG could be more than a passing trend. But why are ESG funds on the rise?

Part of the reason ESG funds performed well in 2023 was because they largely hold technology stocks. Big tech companies such as Apple, Microsoft and Alphabet have some of the best ESG scores among organisations, and as such, tech companies are often represented in ESG funds.

With the interest surrounding artificial intelligence, tech stocks are still hot with investors despite their high valuations. The tech-heavy Nasdaq demonstrates this clearly: It finished 2023 with a year-on-year growth of 43%, one of its best performances in two decades, as data from Bloomberg indicates.

This year could also be a positive one for tech. The US Federal Reserve halted interest rate hikes last year and has signalled two cuts in 2024. For tech companies that need to constantly innovate, lower interest rates translate to cheaper funding for business activities and an improvement of their cash flows.

Yet, tech stocks, being growth stocks, typically reinvest earnings for expansion rather than pay out dividends. So, what should dividend seekers do?

An often-overlooked fact is that there are some stocks with good ESG ratings of A to AAA in industries that one may initially assume to be ‘carbon-heavy’ or less prominent on the ‘green’ front, such as utilities and consumer staples.

While utilities and consumer staples sectors may not be top of mind for dividend seekers when it comes to ESG investing, some utilities companies are innovating to develop sustainable technologies. With relatively stable performance and consistent dividends, these sectors are defensive in nature.

Any good investor knows that diversification is key to ensuring a robust investment portfolio. One way to diversify your ESG stock portfolio is to include consumer staples firms that produce essential items. Falling interest rates spell good news for such stocks: Lower rates can reduce household debt costs and improve spending power, upping the demand for the items these firms produce.

Greenwashing risk

With the above known benefits of high ESG scores, it is no surprise that companies are quick to showcase their ESG credentials for commercial gains. Greenwashing is a term to describe incidences where companies make false statements about their ESG practises to customers interested in sustainability initiatives made by their favourite brands. Greenwashing can be deliberately giving false statements, or making overly ambitious targets that are not tracked or reported subsequently. In some cases, it can be a case of a genuine lack of ESG knowledge.

Greenwashing can lead to legal and reputational damage and the customers’ loss of confidence in a company’s products or services, leading directly to a loss of revenue and worse, in the case of a public listed company, a drop in the share price.

One way to combat greenwashing is to rely on data and a transparent framework for assessing ESG credentials. MSCI ESG rating framework is one of many examples available in the market that investors can utilise in assessing a company’s ESG initiative. When choosing a data provider, investors should check on some critical factors.

ESG scoring systems should give credit based on performance rather than merely for disclosing information. Transparency in data measurement, analysis, and impact assessment is vital. Standardising methodologies and using robust data can contribute to building trust in sustainable disclosures.

ESG investing is here to stay

First, there are serious governmental pushes across the globe for climate action. For instance, the European Union’s Green Deal is holding fast to its aim to make the EU climate-neutral by 2050 and promote sustainable economic growth.

Many consumers also call for companies to be transparent with their ESG ratings, and how their standards are measured. In Japan, companies are required by law to disclose ESG information. The country’s government has also established guidelines for responsible investing.

These developments have compelled companies to prioritise their ESG efforts. Moreover, companies with high ESG ratings typically outperform financially.

While initially viewed as a momentum play, there is evidence suggesting that ESG investing not only enhances corporate financial performance but also benefits investors' portfolios. ESG considerations have become increasingly integral to the investment process. An MSCI study revealed that high ESG-rated companies tend to exhibit greater profitability and dividend payments compared to low ESG-rated companies.

Smart investors need to recognise ESG is here to stay and be ESG aware when reviewing their portfolios. Investments with globally recognised ESG ratings will provide a credible view for assessment. Portfolio reviews will need to include a review of a company’s ESG rating as well.