Business malpractices are pretty hard to be swept under the rug any longer. Moreover, pursuing positive changes has gripped the world recently as the world increasingly faces environmental and sustainability concerns.
Recently, ESG investments were pushed into the limelight after the Senate voted to overturn a Labor Department rule that permits fiduciary retirement fund managers to consider ESG factors in their investment decisions. President Joe Biden said that he would veto the bill when it reached his desk.
Republicans have criticized ESG as being “woke” capitalism and that it reflects liberal political beliefs. But what exactly is ESG? And how can one use it in investing? Let us delve deeper to answer these questions.
What Is ESG?
ESG stands for Environmental, Social, and Governance, which essentially refers to a certain set of rules a company must follow to comply with standards in the light of socially helpful issues such as climate change and sustainability.
Environmental: The ‘E’ in ESG takes care of the company’s responsibility toward the environment. The company’s operations that can impact the environment, like sourcing natural resources and waste disposal, also have the ability to impose financial risks. Companies that fail to take responsibility for the environment can face regulatory risks, prosecution, and loss of reputation, which can impact shareholder returns.
Social: The ‘S’ refers to social responsibility, encompassing companies’ interaction with their employees and in the community where their operations lie. DEI (Diversity, Equity, and Inclusion) is a crucial component of the social factor. However, this factor is hard to measure as investors have to rely upon the information provided by management and distinct methodologies.
Governance: The ‘G’ implies the company’s governance and decision-making tactics. This reflects how company participants implement social and environmental values into policy making. This criterion relates to the assurance that a company is not engaged in unlawful activities that conflict with shareholders’ interests.
ESG Measurement: ESG activities can be objectively measured by an ESG score. MSCI rates companies on an AAA-CCC scale relative to the standards and performance of their industry peers, considering 10 themes and 35 key ESG issues. The MSCI model asks four key questions:
- What are the most significant ESG risks and opportunities facing a company and its industry?
- How exposed is the company to those key risks and/or opportunities?
- How well is the company managing key risks and opportunities?
- What is the overall picture for the company, and how does it compare to its global industry peers?
What Is ESG Investing?
Investors have turned toward ESG investing, sometimes called ‘impact' or ‘socially responsible’ investing, to align their investments with good corporate citizenship and environmental sustainability.
Investing in companies that meet certain ESG criteria and make it part of their measure to operate as transparent firms has emerged as an excellent strategy. This type of investing combines seeking financial gains while bringing positive change to society.
The following chart shows some criteria that investors look into for ESG investing:
The concept of ethics and beliefs as an investment strategy is nothing new. However, combined with Corporate Social Responsibility (CSR) and increased awareness, ESG investing has brought about a new dawn of social accountability. Moreover, investors have recognized the climate crisis as one of the biggest challenges the world is facing right now.
One of the reasons for investing in stocks with good ESG scores is that these companies can avoid blowups that a company faces for unethical practices. Also, these businesses tend to be largely followed by investment firms. However, ESG investors could leave out key defensive sectors like tobacco and defense as it does not align with their investment strategy.
What Kind of Impact Could ESG Investing Have on Your Portfolio?
Although companies that fail to live up to the standards of a good corporate face regulatory risks, no central authority enforces ESG criteria. However, socially conscious investors choose ESG stocks. Also, investing in sustainable companies could be financially rewarding.
On the other hand, some argue that companies that focus on ESG could do so at the expense of profits, leading to lower shareholder returns.
Additionally, ESG investing is still relatively new. Therefore, a comparative study of ESG companies to other companies is still inconclusive.
A team of experts at the MIT Sloan Sustainability Initiative stated that the ESG criteria, however flawed it may be at present, is the best way to measure transparency and corporate responsibility.
Morningstar has found that ESG funds are more resilient than traditional funds. They found that 77% of ESG funds that existed 10 years ago have survived, compared with 46% of traditional funds.
What Does the Future Hold for ESG Investing?
The top-down approach to ESG is expected to be flipped around in the modern internet age. “ESG 2.0” is characterized to be more data-driven, helping investors to make more informed decisions. Expectations about regulatory guidance ramping up on carbon emissions and other ESG attributes are also high.
Moreover, investors are becoming increasingly passionate about making a difference in the world. One poll by Domini Impact Investments shows that more than 50% of respondents would be willing to sacrifice performance on their investments to achieve ESG goals.
Encouraged by the commitment to fight climate change, the overall intent of U.S. investors is clear. According to a study, ESG Assets Under Management (AUM) in the United States would more than double, from $4.5 trillion in 2021 to $10.5 trillion in 2026.
The market is anticipated to open up more on ESG initiatives in the future, benefiting investors.
Best,
The MarketClub Team
su*****@in*.com
ESG is not what I invest for, making money is the goal.