The concept of sustainability in investing is fast becoming as important as financial returns. At what point do concepts such as environmental awareness, social responsibility, and economic impact intercept finance and investing? Enter, ESG investing.
What exactly is ESG?
ESG investing refers to environmental, social, and governance investing. It involves intentionally selecting investment assets through companies that preserve the environment, utilize good governance, and engage in acceptable social practices. With ESG investing, you are purchasing assets that focus not only on profitability but on:
- Energy usage
- Fuel emissions
- Climate change
- Water management
- Employee relations
- Community engagement
- Audit practices
- Political involvement
We are in an ever-changing world. The effects of climate change, social movements, and proper governance of corporate boards are becoming increasingly important. For those looking to allocate their savings to companies at the forefront of these three movements, there is a dedicated industry to help you with your investment journey. Finding the best ESG companies will help you accomplish your financial goals and help make a stronger global community.
What does ESG mean in investing?
For some, the idea of investing through assets backed by sustainable practices may not seem like such a big deal. For many, however, it sure makes a huge difference. These investors want their money in companies that align with their values, and positively impact society and the environment.
In fact, according to a July 2021 report from the Global Sustainable Investment Alliance, sustainable investments total $35.3 trillion, or more than a third of all assets in five of the world’s biggest markets — United States, Canada, Japan, Australasia, and Europe.
One demographic helping drive ESG investing? Millennials — in Canada, numbering approximately 8.3 million. As research firm Strategic Insight projects, between 2016 and 2026, approximately $1 trillion in personal wealth will be transferred from one generation to the next. Roughly 70% of this takes the form of financial assets. In their report Swipe to invest: the story behind millennials and ESG investing, investment research firm MSCI cites one Bank of America finding that “88% of high-net-worth millennials are actively reviewing the ESG impact of their investment holdings.”
In short, millennials — along with investors of all generations, of course — are interested in aligning their investments with their values.
What Qualifies as an ESG Investment?
As explained above, the principles of ESG investing center around the core concepts of environmental, social, and governance factors.
Environmental Factors: These factors involve activities that affect the environment. There’s a buzz and urgency around the goal to create a safer and more sustainable environment. This means paying close attention to companies and organizations with operating processes that do not contribute to environmental pollution or climate change. Other environmental aspects include engaging efficient energy practices, embracing biodiversity, and effectively managing natural resources.
Social Factors: The social factor in ESG investing focuses on issues that deal with human interaction, employment standards, personal data management, privacy, equality, diversity, and human rights. Some companies have faced criticism for harsh labor standards detrimental to human health, safety, and well-being. These factors are essential to ESG investors and may affect the decision to buy a company’s stock.
Governance Factors: ESG investing focuses on transparency in corporate affairs. This includes political involvements, ethical standards and practices, financial audits, and shareholder voting rights. Investors passionate about ESG, particularly corporate governance, need information on board composition and audit practices to ensure that executive leadership promotes fair policies.
ESG Investing vs. Impact Investing
A common question investors ask: what is the difference between ESG investing and impact investing?
Theoretically, these are interchangeable as they’re driven by similar principles. There are, however, some differences based on focus areas and specific goals.
While ESG investing encourages participation in companies that adhere to environmental, social, and governance standards, impact investing is broader. It focuses on the overall positive impact of a specific goal or project on society and the economy, plus a financial return. Sectors most commonly addressed include, according to the Global Impact Investing Network include sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education.
Another term commonly grouped with ESG investing and impact investing is socially responsible investing. Think of SRI as one step beyond ESG. As Investopedia explains, SRI does this “by actively eliminating or selecting investments according to specific ethical guidelines. The underlying motive could be religion, personal values, or political beliefs.” One example is Halal Investing, where portfolios are built in adherence to Islamic law.
How to Invest in ESG Assets
You can get involved in ESG investing by buying into companies that align with ESG principles. For instance, this can be as direct as purchasing individual company stocks or investing in diversified assets such as exchange-traded funds (ETFs) indexed solely on ESG metrics. Investors can also buy into mutual funds that focus on ESG investing or green bonds.
The basic ESG principles are broad. Consequently, it’s possible to identify different assets that meet your goals as an investor. For instance, your investment portfolio can focus on companies in the renewable energy space or organizations that promote equal human rights and diversity.
How is ESG Calculated
You can identify ESG focused companies by reviewing their corporate reports for standards that conform to guidelines set by recognized global bodies such as the United Nations Principles for Responsible Investment (PRI) or the Global Reporting Initiative (GRI). Third-party ESG screening/rating companies like MSCI and Sustainalytics provide helpful reviews and ratings of companies to show how they rank and measure against ESG related risks. MSCI recently released an infographic detailing how companies are given their ESG score, while Sustainalytics has produced two videos explaining their ESG Risk Ratings and how these ratings work.
It’s important to note: Many companies will show up on these screens that you might not agree with. In other words, even the daunting industries have good players. Building a better future will need to happen at all companies, not just the ones professing a greener future.
ESG Focused Industries
ESG practices are not exclusive to specific industries. Different companies across industries can adopt good environmental, social, and governance practices. Examples of ESG standards include pharmaceutical, renewable energy, financial services, construction, building, utilities, and transportation. Most companies that adhere to ESG guidelines provide information on their process in a detailed corporate report.
Why Should I Invest in ESG Assets?
Investors have shown more interest in ESG investing over the years. This shift hinges on various factors.
Firstly, many people relate to the need for a more sustainable environment. With our continuous energy consumption levels, there is a demand for safe energy generation and environmental emissions. For example, if you advocate for clean air and water, it may justify your need to gear towards companies that practice and promote energy efficiency and practical environmental waste management.
Secondly, personal or social collective ethical values can be an excellent reason to invest in ESG assets. Religious perspectives have since influenced investing decisions, and it is not surprising that beliefs and ethics can drive preference in investing and finance.
Finally, our heightened awareness of and push for acceptable human relations may indeed play a factor in the overall performance of a company. A conscious disregard of specific social issues — for example, human rights, diversity, and child labor — may lead to a mass boycott of certain companies and investment funds. It’s therefore incredibly important to pay attention to investments that are associated with environmental and social responsibilities.
The Future of ESG Investing
Public companies have shared disclosures in financial statements on social responsibility and governance in the past. Given the growing awareness and sentiments held by investors on these issues, many will continue to do so.
Investment companies are responding to the increased need for sustainable investments, by issuing mutual funds and ETFs solely based on environmentally and socially best practices.
The ESG investing trend is more likely to persist as more investors understand the importance of sustainability alongside profitability. While we previously mentioned the PRI — the six voluntary/aspirational Principles for Responsible Investment — there is no true global consensus on ESG investing standards. As a result, practices may differ across industries or countries. It’s therefore essential to review companies’ specific disclosures and financial statements associated with ESG standards.
With profitability, there have been conflicting views on the performance of ESG-focused companies. Simply put, there is a misconception about ESG investments. Many think if you focus on the environmental, social, and governance as a requirement, your upside is limited, and underperformance is likely. However, ESG-focused companies have been resilient in downturns and have recently done exceptionally well in practice. In conclusion, a key takeaway is to focus on both ESG principles and financial performance when choosing ESG investments. After all, the main goal of investing is to make returns.