Whether you’re a conventional or sustainable investor, you’re sure to encounter environmental, social, and governance approaches in your portfolios.

Here are three tips to keep in mind.

1. ESG funds will stay popular - that may transform your investing behavior


Despite a disappointing year for markets, money flowed into ESG funds.

Over the full year, the Morningstar US Sustainability Extended Index lost 18.09%, versus a 19.4% decline for the Morningstar US Market Index. And US Google Trend query volumes for “ESG” exceeded “index fund” in 2022 and are up about 6 times the average of 2018-19, says Jessica Rabe, a strategist at DataTrek Research.

Meanwhile, conventional asset managers have widely adopted ESG analysis in their investment selection process to help mitigate risk.

Rabe’s takeaway: ESG “continues to gain momentum, which tells us Americans increasingly care about this theme. As such, ESG is an important investment factor to stay on top of as asset owners allocate incremental capital based on its principles.”

That could help change the dynamic for individual investors.

Using ESG metrics has helped companies and investors reduce risk, but it also helps investors express their values through their portfolios. Such values engage people with their money, leading to better outcomes as people get closer to retirement, notes Bob Mann, president of Morningstar Sustainalytics.

In addition, younger investors are also eager to align their investments with personal interests and values.

2. Recommit to diversifying—even if you already own a diversified sustainable fund.


That includes diversifying by style. This year showed that the big-cap growth stocks favored by many sustainable funds cratered, the energy stocks that many shunned outperformed, and value stocks glittered.

As a result, the Morningstar US Sustainability Large Cap Broad Growth Index lost 30.8% in 2022, versus 10.1% for the corresponding value indexes.

Meanwhile, the majority of sustainable equity funds have growth tilts, notes Morningstar’s Jon Hale. “With interest rates rising this year to cool inflation, [their] future earnings are no longer valued as highly, especially amid concerns over a slowing economy,” Hale says.

Even for broadly diversified funds, returns varied widely. Consider that over the past 12 months, the iShares ESG Aware MSCI USA ETF ESGU fell 20.3%, the SPDR S&P 500 ESG ETF EFIV fell 18.4%, and the Vanguard ESG US Stock ETF ESGV fell 23.3%.

The wide dispersion of returns among these popular sustainable index funds is “a useful reminder that it’s better to allocate capital to a few ESG products rather than only one for those interested in this investment approach,” says DataTrek’s Rabe.

3. Open your proxy ballots from companies whose shares you own upon arrival.

ESG shareholder resolutions are on the rise. They’re an important signal to management that investors care about the ESG risks to the companies they own.

Jackie Cook, director of stewardship at Morningstar Sustainalytics, expects a renewed focus on executive pay in the AGM season, given the rise in the cost of living. She also expects to see climate and biodiversity figure into the proxy season, including investor requests for reports analysing how companies with large supply chains will deal with deforestation or scope 3 emissions.

Sara Mahaffy, ESG strategist at RBC Capital Markets, agrees: “We are seeing more focus on assessing the credibility of corporate climate commitments, with asset managers looking for companies to set short-, medium-, long-term, science-based climate targets, as well as companies to publish detail action and progress to back up their commitments.”

ESG Investing Is Here to Stay

ESG offers a fuller version of risk—as well as the opportunities that come with that risk. Sustainable funds can be a good place to start as you think about your portfolio in 2023.