How does ESG investing work?
ESG (environmental, social and governance) investing is grounded in the realisation that the performance of a business is intrinsically linked to environmental and social factors, as well as how it drives positive change through governance. Consequently, this investment strategy involves putting capital into companies that perform highly on such issues, which is determined by evaluating their environmental, social, and governance impact.
There are many tools for measuring a company’s ESG, including its own sustainability reports and platforms such as the Task Force on Climate-related Financial Disclosures (TCFD), the Dow Jones Sustainability Index (DJSI), Morgan Stanley Capital International (MSCI) and FTSE4Good.
The principles of ESG investing aren’t exactly new, however. Religious and ethical beliefs have long impacted investment choices, as has the concept of corporate social responsibility (CSR). ESG investing is a more precise concept, though, and helps investors get a more holistic view of the businesses they invest in and ultimately enables them to influence positive changes in society through their backing.
What topics fall under ESG?
Here, a company’s impact on the environment is assessed. This includes aspects such as:
- An organisation’s carbon footprint
- Its water and energy efficiency
- Its impact on deforestation
- Its green employee incentives
- Its recycling and disposal practices
This measure gauges a company’s social impact, both within the company itself and in the wider community. Examples include:
- A company’s working conditions
- Employee training and development
- The equal opportunities provided and level of diversity and inclusion in hiring
- Its philanthropic work
- Its supply chain sourcing
When looking at a company’s governance, investors want to see that its board and management are driving positive change. Among the aspects considered are:
- Issues around excessive executive pay
- Board diversity and structure
- Legal compliance
- Transparency of shareholder communications
What are the benefits of ESG investing?
When considering the benefits of ESG investing, the advantages for the planet and society are clear. Benefits for the investors themselves may not appear so clear-cut, but ESG investing does offer a number of advantages:
Although some believe that an ESG strategy involves accepting a trade-off in terms of returns in exchange for “doing good”, research suggests that the opposite is actually true. According to a paper by abrdn.com: “ESG factors can have a positive effect on corporate financial performance – with evidence showing that higher-quality companies tend to make better profits.” As a result, their shares will perform better, which leads to more competitive returns for investors.
Reduced portfolio risk
Companies that fail to address environmental, social and governance issues face much greater risks than those that do deal with them. For example, non-compliance with certain laws can see a business land in hot water, something that could ultimately impact its finances and reputation. Companies actively working to tackle these issues should see fewer disruptions and therefore provide more reliable financial returns for investors over time.
Making a positive impact
By putting money into companies that aim to do good for the world and the people in it, ESG investing is a great way to make a positive difference while simultaneously benefiting financially. The more that ESG-focused companies gain greater investment over their counterparts, the more the latter will be forced to adopt these principles themselves. Investing in ethical companies also allows you to build a portfolio that aligns with your own worldview, which can provide greater personal satisfaction.
How can I start investing in ESG stocks?
There are a number of ways to evaluate corporate ESG performance, from a company’s own sustainability reports to external platforms, all of which can help you find the right businesses to invest in. When looking at company reports, however, be sure to look for those that follow ESG standards established by the Global Reporting Initiative (GRI) and/or the United Nations Principles for Responsible Investment (PRI).
If you’re unsure where to start, or feel you’d benefit from some professional financial advice, then please don’t hesitate to get in contact with the team here at Oury Clark.