What To Know About ESG Investing

Published on: 13 October 2022
by KnowESG
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ESG investing is the idea of incorporating non-financial variables into investing - to bring notice to a variety of world issues to stakeholders and stockholders alike. It’s a concept that has grown in popularity over the past few years as physical evidence of anthropogenic climate change has become incontestably visible. The overarching premise is that we must radically alter the way we measure value in our economic systems, away from the extractive and acquisitive, towards the sustainable and regenerative. 

From an investment perspective, this means supporting companies that follow ESG principles and who are, measurably, trying to improve the way they operate their business. And while ESG is still evolving, and there are some simple investment rules we can follow, it’s important to start with some basic aspects of ESG investing that will help remove any confusion and provide clarity.

Understand What It Is

ESG stands for ‘environmental, social and governance’. When investors are assessing companies, ESG evaluation is based on how well a given business performs, via transparent reporting and assessment, within these three ‘pillars’. The aim, then, is to understand what all the non-financial risks are in a company’s operations, relating to ESG.

  • Environmental focusses on resources and how effectively a company uses them. Are there opportunities to reconsider how water, packaging, plastic, or fossil fuels are currently used? Does this signal a switch to renewable energy sources to power company operations, supply chains, or workplace climatic conditions? While these criteria will differ hugely from company to company, the point is to start quantifying how energy and resources are used, identify how to improve this, and put a plan into action.

  • Social looks at how the company manages relationships with employees, labour regulations, and the communities within which it operates. Where can current inequalities be identified in hiring practices, gender, racial diversity, pay gaps, working conditions, health and safety standards, and access to benefits? 

  • Governance considers leadership and administrative aspects, shareholder rights, executive compensation, board behaviour and performance-aligned benefits, and diversity in management. From the regulatory standpoint, it seeks to assess potential corruption and unfair corporate practices. 

Why ESG Is Such A Big Deal

ESG investing may feel ‘new’, but we just experienced an evolution in the structure of what was, since the 1960s, called ‘socially responsible investing’. It gained traction in the late 1990s and it has evolved into corporate social responsibility (CSR) at the turn of the century, and now the impact investing and ESG we see today.

ESG was coined in 2004 and is closely intertwined with impact investing. But why ESG is taking centre stage right now has a lot to do with the current state of the world. Looking around, people are worried about various things such as:

  • Visible effects of anthropogenic climate change

  • National security weakened through those impacts

  • Supply chain dependence and diversity

All these factors naturally affect the economic systems we have in place. The narrative of the past several decades has been the relatively unfettered forward march of capitalist policy-driven globalisation and corporate deregulation, both of which have contributed to a resource use expansion that now strains the carrying capacity limits of our planet.  

However, investing, however well intentioned, must be a pragmatic business decision. Acceptance of ESG has thus expanded as investors realise that focussing on ESG initiatives generally doesn’t affect their portfolio, ROI or bottom line at all - which was the main reason for initial investor hesitancy. ESG is, ever more, turning out to be a ‘win-win’, since while even pro-ESG investors may be ok with lower returns on certain companies that operate responsibly, even those who generally oppose ESG policies come out positively as they are investing in stocks that, generally, provide higher returns in the long-run. 

Perks Of ESG Investing

As investors continue, they realise that ESG investing offers certain benefits that ‘traditional’ investment pathways did not:

  • It provides satisfaction. Akin to the idea of donating money to a charity, ESG investing means you’re providing financial support to a company that wants to make a bigger difference in the world. And unlike a charity, you’re getting dividends by investing.

  • Supporting companies that share your values. Do you care about the environment? How about workers or the community you live in? Values guide our actions and thoughts and ESG investing taps into that and provides companies that hold similar values to you.

  • You don’t need to pay constant attention to it. ESG investing has a bit of built-in consistency to it. In other words, once you’ve done your research - or as much of it as you want - you can invest in the company without worry. So long as the business doesn’t think destroying forests is a good idea you can take a hands-off approach.

How ESG Is Measured

There are several firms out there that measure ESG and provide a score to companies. The larger ones are Sustainalytics, MSCI and Refinitiv. Each site has its own measurement or ‘grade’ they assign to each company, and these differ since they are more or less relevant for differing company circumstances. There is, at present, no ‘universal’ measurement for ESG, and this is fine because ESG promotes diversity and variation in business thinking. Differing requirements are natural and there is no single, top-down, mandated approach.

How ESG is measured is based on a company’s research into specific categories of ESG. For example, Refinitiv looks into the performance, commitment and effectiveness of 10 main themes. How ESG is measured to them would be based on their own internal views of those 10 themes and how they specifically relate to the company’s circumstances.

How To Invest With ESG In Mind

As mentioned before, ESG is putting non-financial variables into a financial decision. Companies are supplying this through policies, milestones, and hard data. As a result, and as with any ‘traditional’ investment opportunity, investing with ESG in mind comes down to screening each investment option and understanding the company thoroughly before investing.

The level of research varies depending on which financial instrument you’re choosing. Investing in individual stocks requires the most research, whereas investing in mutual funds or ETFs will give you narrower selections or someone investing in an ESG company for you. Overall, it’s best to talk to a financial advisor if you are thinking of investing with ESG in mind.

Is ESG Investing A Fad?

Let’s stand back from the acronym and look at the bigger picture. We’ve had other acronyms before, so you may be forgiven for being hesitant. Larger firms today are looking to have ESG-focused financial instruments or apply these standards to existing products. So far it’s not the standard yet, but it does show promise and progress. Currently, 79% of US individual investors and 99% of millennial investors are interested in ESG investing. And that’s just it, this is the current model we are exploring that will become, in some form or another, the new ‘standard’. We are looking at a framework for the implementation of business change that could prove restorative to our planet’s future, rather than simply destructive. This is a necessary shift in the way we do business.

But this article is about investing. So, for one, we can see that companies are paying attention to investors and will care more and more about their ESG ratings as a result. Such behaviour shows that companies are starting to understand that focus on the betterment of society, communities, and the world, can be a central premise of their business operations, and that simply underlines the companies that are future-proofing their interests, which in turn make them a better opportunity for investors.

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