In recent years, Wells Fargo noted in an 'Investment Strategy' note of this Monday, the concept of Environmental, Social, and Governance (ESG) investing has gained significant popularity among investors, driven by its appeal to a variety of personal values. Through investments in such companies, ESG investing promotes environmentally sustainable and socially responsible business practices, as well as sound corporate governance structures.
Wells Fargo said ESG consideration, which is often represented by a score or rating, can be impacted by other investment characteristics:
- Asset class: Small-cap and emerging market stocks, on average, tend to show a distinctively lower ESG score than large-cap companies, owing to a relatively lower country or business standard.
- Sector: The type of business can have a major impact on a company's ESG score as well. For example, Materials, Energy, and Utilities companies generally have a higher carbon footprint, which can result in a lower ESG score than sectors like Information Technology.
- Stock selection: Within the same sector, a higher ESG score is more often found in high quality, growth-oriented, and defensive companies.
According to Wells Fargo, these interactions are often manifested in ESG performance. It cited a chart showing that over the past 12 months, as market leadership switched to lower- ESG-score segments such as small-cap and cyclicals, the MSCI USA ESG Focus Index underperformed the broad market MSCI USA Index.
Wells Fargo added: "To develop a diversified investment plan and potentially avoid concentrated risks, we prefer to integrate ESG into the portfolio construction process. ESG consideration can be a vital ingredient in the investment recipe, but it should not be the only one."