What is ESG – Environmental, Social, and Governance ? How does it relate to investing? Why is environmental, social, and governance (ESG) investing so important in this era?
If you are an office worker who is interested in investing or wondering why the company you work for has changed its management approach to focus more on sustainable organizational development by dividing the focus to the environment instead of just focusing on revenue, profits or customers that must increase each year, you need to get to know ESG urgently if you don’t want to fall behind the trend.
ESG (Environmental, Social and Governance) is an investment in the environment, society and governance, which is currently a popular concept for sustainable corporate development. Because it is not only concerned with climate change caused by industries that have encroached on the environment too much, but also means improving the business model to stand out from competitors by using standard risk management.
“ESG: A method for screening potential investments”
ESG has become a behavioral model that shows investors’ concern for the environment and society. If any investment is conducted according to the ESG concept, it will be considered a potential investment because ESG will have environmental criteria that help consider how the company is contributing to protecting the environment, including the need for corporate policies to cooperate on climate change at present. There are also social criteria that examine how the organization manages the relationship between employees, customers, and the communities in which it operates. Finally, there are governance criteria that look at the involvement of the company’s leadership, executive compensation, auditing, internal controls, and shareholder power.
How does ESG work?
In recent years, more investors have shown interest in allocating their investments to organizations with ESG-based practices. As a result, brokerages and mutual fund companies have started offering exchange-traded funds (ETFs) and other financial products that follow ESG investing strategies. Robo-advisors Betterment and Wealthfront have also begun promoting their ESG-minded offerings to younger investors.
“ESG investing is sustainable investing.”
ESG investing is sometimes referred to as sustainable investing, responsible investing, impact investing or socially responsible investing. ESG investors are increasingly informed about the investment choices of large institutional investors, such as public pension funds. According to an industry report from the US SIF Foundation, investors holding $17.1 trillion in assets are making ESG investments. In 2020, investment in ESG businesses increased by $12 trillion from two years earlier. In 2021, ESG-specific mutual funds and ETFs reached $400 billion, a 33% increase from the previous year, and are expected to grow rapidly in the coming years.
“Environment, Society and Governance”
ESG investors seek to ensure that the companies they support are environmentally responsible, good corporate citizens, and have responsible management teams and leadership. Evaluating leaders’ awareness of climate change can look at climate policies, energy use, waste, pollution, natural resource conservation, and animal treatment. This assessment can also help assess the environmental risks a company may face and how it is managing them.
“Human influence is the cause of global warming.”
Human influence is causing global warming, and some climate disruptions have been locked in for centuries, according to a report from the UN Intergovernmental Panel on Climate Change. The report is sounding the death knell: If we don’t kill coal and fossil fuels, it will kill us and our planet too.
Socially responsible investing
Investing in social responsibilities means looking at a company’s relationships both internally and externally, whether it’s a manufacturer’s compliance with ESG standards, the percentage of profits a company gives to local communities, or its support for employee volunteering. The workplace also reflects the health and safety of its employees, so it becomes an important part of telling how much a company cares about its employees.
“Investors seek companies that promote ethical and social awareness.”
Investment in governance
ESG governance standards will certify whether a company uses sound and transparent accounting practices. Because ESG business practices mean that a company pursues integrity and diversity in its leadership selection and its responsibility to shareholders, most investors will want assurances that companies avoid conflicts of interest in selecting board members and senior executives, do not use political contributions to obtain preferential treatment, or engage in illegal behavior.
“What investors want is assurance that your company is operating transparently.”
ESG criteria
Investment firms that track ESG investing often set their own priorities. For example, Boston-based Trillium Asset Management, which had $5.6 billion under management as of December 2021, uses a variety of ESG factors to help identify companies with strong long-term performance. The analysts’ criteria list the following areas for specific industries and companies:
Environmental
- Publish a carbon or sustainability report
- Limit pollution and harmful chemicals
- Try to reduce greenhouse gas emissions and CO2 footprints.
- Use renewable energy sources
- Reduce waste
Social aspect
- Operating an ethical supply chain
- Avoid migrant workers who may have concerns about workplace safety or employ child labor.
- Support LGBTQ+ rights and promote diversity in all forms.
- There is a policy to prevent sexual misconduct.
- Pay fair wages
Regulatory aspects
- Promote board diversity
- Accepting the organization’s transparency
- There is a person other than the CEO as the chairman of the board.
- Election of the committee to oversee this matter
Advantages of ESG Investment
ESG criteria help investors avoid the consequences that arise when companies act in risky or unethical ways and are ultimately held accountable for the consequences. For example, BP’s 2010 Gulf of Mexico oil spill and Volkswagen’s emissions scandals both cost the companies billions of dollars in stock prices.
“The value of ESG investing depends on how much investors push for change in investment models.”
Changing the business model and investment of companies to be in line with the ESG concept can help add value to the business operation model. Because currently, many investors are encouraging companies that they have invested in or companies that they are interested in investing in to change their operating model to focus more on sustainability. However, the investment trend is still based on principles that are realistic, measurable, and practical.
Disadvantages of ESG Investment
The downside to ESG investing is that you can’t own every stock available in the market. After all, tobacco and defense, two industries that many ESG investors avoid, have historically generated above-average market returns and are recession-proof. In other words, U.S. investors may be sacrificing a small amount of return in exchange for an investment that fits their value.
“Most investors are willing to sacrifice a small amount of their profits to invest in businesses that are aligned with ESG principles.”
According to a survey of Investopedia and Treehugger readers, nearly half of ESG investors said they would accept a 10% loss over five years to invest in a company that promises to implement ESG principles. But 74% of respondents said that the valuation of a business is more important to them, meaning they are still more concerned with money than taking a loss to protect the environment. This suggests that sustainable investments like ESG are becoming a premium, putting the investment model in an expensive category.
How do you know which investments are ESG?
Several financial firms have released ESG ratings and scoring systems in recent years. For example, MSCI has released a comprehensive scoring scheme for more than 8,500 companies worldwide, providing them with letter grades and scores based on their compliance with ESG standards and initiatives. Many other companies also offer ESG scores on the stock exchange.
Conclusion
ESG investing focuses on companies that practice positive environmental, social and governance principles. Today, investors are increasingly keen to align their investments with ESG-related companies and fund providers. This shift in investor sentiment is making investing an exciting growth area that also has a positive impact on society and the environment.
Reference:
What Is Environmental, Social, and Governance (ESG) Investing?
