ETFs, ESG, SRI — sometimes it seems like people in the financial world are just playing with magnetic refrigerator letters. To understand these terms and more (plus how to pronounce them), check out our easy-to-read cheat sheet of commonly used terms.
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It might be easier to think of Asset Classes as “asset categories” for investment, with the different categories having distinct characteristics relating to risks and financial returns, as well as to specific laws and regulations. A diversified investment portfolio would have investments in each category. Deciding how much to deploy or invest in each class/category can vary greatly based on age or risk-tolerance, among other factors. Understanding the characteristics of each is key to making informed investment decisions. Highlighted below is a summary of Asset Classes:
- Cash and cash equivalents - This asset class represents all types of bank accounts and represents low-risk, and generally low financial returns, for the investors.
- Fixed interest or fixed income - Fixed interest assets represent investments that offer a set financial return over a specific period, usually 1-3 years. These types of investments can include corporate or government bonds and mortgages. This asset class is not highly volatile but has a higher risk profile and higher financial returns than cash.
- Equities - Equities include domestic or international investments in companies or funds that invest in companies. Public equities invest in public companies, while private equity invests in companies that are privately held – which means their shares are not traded publicly. This type of investing enables the investor to become a part-owner, or shareholder of a company. Equities represent the highest risk volatility (potential to change in value) of all asset classes and can achieve much higher investment returns.
A special certification provided to for-profit companies based on social and environmental performance and company governing documents. The certification is provided by the non-profit, B Lab. Companies pay an annual fee based on annual sales and must re-certify every three years.
A benchmark is a standard or measure. Benchmarks can be used to measure the risk and return of a portfolio. The S&P 500 index is often used as a benchmark for stocks, while US Treasuries are used for measuring bond returns and risk. Firms that measure ESG ratings also provide benchmarks for the standard among those companies that prioritize ESG factors.
TL;DR: think averages and the market standard you want to beat.
Carbon offsets are investments by an individual or organization in projects meant to compensate for harmful greenhouse gas emissions and achieve carbon neutrality. The projects typically focus on carbon removal or avoiding future emissions, like planting trees or renewable energy generation. Each carbon offset credit represents a reduction of one metric ton of greenhouse gas emissions, and there are two types, voluntary or compliance-related, depending on whether it’s part of a sustainability goal or a requirement to stay below government emission caps. The trading of emission credits is called the carbon market.
A concessionary return refers to an investment that sacrifices financial gain in favor of a social benefit. Some investment professionals have labeled ESG-focused funds and companies concessionary because they believe investments aimed at social impact would sacrifice potential return. Today, an expanding body of data indicates that is not usually the case, and in fact, many reports show that ESG investments actually outperform the market.
Research and analysis of a potential investment in preparation for a business transaction. Think "do your homework before you invest."
Acronym Pronunciation: Say it like you see it, “ee es gee”
ESG Investing seeks positive returns and long-term positive impacts on society, the environment, and the performance of the business. These investments focus on Environmental, Social, and Governance (ESG) factors broadly summarized below:
- Environmental Factors - these factors assess how a company manages its greenhouse gas emissions, waste management, and energy efficiency both directly as a business and impacts from its supply chain activity and consumer use of its products. For this category, think carbon footprint or recycling and reuse practices, for instance.
- Social Factors - these factors assess how a company manages relationships with employees, suppliers, customers and with the communities in which it operates. Criteria relating to diversity, equity, and inclusion is found within this category. For this category, think diversity of workforce, pay gap policies, and ethical and humane treatment of employees and suppliers as examples.
- Governance Factors - these factors assess the rights and responsibilities of different stakeholder groups in the governance of a corporation. These include company leadership, the governance, complexion, and independence of the board, internal controls, audits and shareholder rights. In this category, think executive pay or diversity of the board as examples.
Acronym Pronunciation: Say it like you see it, “ee tee eff”
An Exchange Traded Fund (ETF) is similar to a mutual fund but usually requires a lower minimum investment amount. Both types of funds contain a mix of different stocks that help investors diversify their portfolio. ETFs are different from mutual funds in that they can be traded throughout the day, like stocks, versus mutual funds that can only be purchased at the end of a trading day. For investors interested in ESG, there are a number of ESG ETFs available today. In 2020, the vast majority of ESG ETFs outperformed the benchmarks for their category. ETFs offer tax advantages to investors and tend to realize fewer capital gains than mutual funds. The fees can vary, as well, so it is important to clarify both tax and fees before investing.
Gender Lens Investing
Gender lens investing is an umbrella term for the use of capital to generate a financial return while advancing gender equality. Investors can apply a gender lens to their pre-investment activities, like due diligence, and to the existing funds and enterprises in their portfolio.
For the latter, gender lens investors can consider whether their investment will:
- increase women’s access to capital by supporting women-led or women-founded enterprises
- improve workplace equality through their hiring and promotion practices, as well as pay and benefits
- offer a product or service that advances gender equality
Though these lenses can be subjective, there are tools that can help investors understand the gender impacts of their investments and benchmark their portfolios against their peers.
Green bonds are fixed-income debt instruments that support climate-related or sustainability projects — particularly those that require a lot of capital upfront but provide longer-term benefits. When issued by governments, green may include tax incentives to make them more attractive to investors. Bonds can be purchased by institutions (governments, corporations, or banks) or retail investors as part of a mutual fund or ETF. Because bonds are repaid on a fixed schedule, they are generally considered lower-risk. Unlike with equities, even if the project financed by the green bond is wildly profitable, the purchaser of the bond only makes back what they put in, plus interest.
Conveying a false impression or promoting misleading information to a potential investor or consumer, this includes unsubstantiated claims as it relates to goals or progress of environmental, social or governance practices or progress.
Inflation is the term used to describe increases in the average price of everyday goods and services. When inflation is high, consumers’ purchasing power falls since wages don’t rise at the same pace as costs.
Impact investing is a term coined in 2007 to refer to investments made across asset classes with the intention to create positive, measurable social and environmental impacts alongside a financial gain. To qualify as an impact investment, companies must have clear intentionality, measurement, and transparency around the positive impacts they seek to have. Some impact investors even require that a company's core product or service have societal or environmental benefits, such as electric vehicles, renewable energy, healthy food offerings, or a 1-for-1 model (think Tom’s “buy-a-pair, give-a-pair” model) that brings benefit and impact with each purchase.
The change in prices, or the inflation rate, is measured by the Consumer Price Index (CPI). This index tracks consumer costs in different categories, like food, energy, transportation, rent, etc. While a small amount of inflation – around 2% – is considered normal and even desirable, a long period of surging prices creates a worrying imbalance in supply and demand and can lead to an economic crisis.
Inflation can be categorized into two types based on the cause – demand-pull inflation and cost-pull inflation. In demand-pull inflation, demand rises faster than the capacity for economic output. Cost-pull inflation sees demand remaining stable but prices rising due to supply and production issues.
Acronym Pronunciation: Say it like you see it, “eye pea oh”
An initial public offering (IPO) is the process by which privately-owned companies can get listed on recognized stock exchanges and sell new shares to the general public. The main objective of an IPO is to raise capital for various purposes like growth, research, acquisitions, or repaying debts.
An IPO has many stages, starting with choosing financial specialists, usually investment banks, to act as underwriters and assist with the entire process. As it prepares to “go public,” the company also has to submit regulatory paperwork like the S-1 filing, conduct a roadshow to pitch the shares to potential investors and gauge interest, and decide the offer price and listing price. Typically underwriters first sell shares at the offer price to professional investors before the stock starts trading on the exchange. Once the IPO is completed, shares can then be bought and sold on the exchange by retail investors.
Alternatives to the traditional IPO are also gaining popularity. In direct listings, no new shares are issued and existing shareholders are allowed to sell their stock upon listing. This method is quicker and cheaper since there is no need for underwriters or roadshows, but it comes with its own risks. A company can also make its public debut through a merger with a special purpose acquisition company (SPAC).
A mutual fund is a portfolio of stocks, bonds, or other securities geared toward an investment objective, like rates of return, social and environmental impact, or even a combination of the two.
Individual investors who buy shares in a mutual fund are basically buying a piece of the value of the portfolio’s overall performance. Unlike ETFs, which can be traded throughout the day like stocks as prices fluctuate, mutual funds are valued daily based on overall portfolio performance after the markets close.
Negative Screening (also known as Exclusions)
When deciding what will make it into their investment portfolios, many investors will use what is termed “screening” to ensure they include (positive screening) and exclude (negative screening) the things that matter to them most.
Sometimes referred to as Exclusions or Divestment, negative screens have a long history as a tool for investors to "crowd out" bad actors or to exclude companies whose products conflict with their values. Some common “negative screens” are for things such as alcoholic beverages, pornography, guns, or gambling. Today, investors might exclude fossil fuel producers or companies who ignore human rights in the production of their products. The key here is that a negative screen is used to help keep out companies that the investor wouldn’t want to hold in their portfolio.
Net Zero Carbon
Net Zero refers to the zero balance in the amount of greenhouse gas produced and the amount of carbon removed from the atmosphere. This includes a reduction of greenhouse gasses produced, combined with "carbon offsets" that enable a company to offset its carbon footprint. Think planting trees, investing in renewable energy, and other investments that offset the carbon footprint of a company.
When deciding what will make it into their investment portfolios, many investors will use what is termed “screening” to ensure they include (positive screening) and exclude (negative screening) the thin