Socially responsible investors tend to evaluate businesses on financial performance, but ESG factors are quickly overtaking the field for assessing investments. And although ESG has been on the radar of companies and investors for years, the last 18 months have increased the awareness of our vulnerability, both socially and environmentally around the world. We are quickly coming to realize that it is no longer us and them, but us and us. Environment, social and governance are the principles on which our future will be measured in business.
Environmental, social and governance factors are a subset of nonfinancial performance indicators. The number of investment funds that incorporate ESG factors grew quickly with the start of this year and will be increasing dramatically over the next ten years. There will come a day when we no longer burn fossil fuels or smoke tobacco. And ESG funds will look like nothing we have ever seen before.
When you are an investor you should consider socially responsible mutual funds and exchange traded funds if you wish to purchase securities that meet ESG guidelines. Experts and institutional investors say the ESG framework and set of criteria are subjective. It all depends on your priorities and how you understand the world. For socially responsible investments they recommend to do your own research. Evaluate companies, investigate impact investing principles for socially conscious investing. Because it is an emerging field, ESG investments do not have a defined investment process that you can find at any brokerage firms. So, for now, you will need to roll up your sleeves. But that also means greater opportunity.
Environmental, social and corporate governance
Data in fields of green business management, the environmental and social aspects of corporate governance refers to intangible assets within corporations. They are a form of corporate social credit scores. According to research, evidence of intangible assets are comprising increasingly greater proportions of future enterprise value. The ESG data are used for a variety of specific purposes which contribute to the betterment of humanity, as opposed to solely focussing on profit for investment portfolios. It is well proven that energy efficiency and capital markets are not mutually exclusive. The ultimate objective will be the measurement of non financial considerations related to the sustainability of a company and impact on society.
Environmental, Social and Governance Criteria: Pros
Some investors have come to consider environmental socio-demography criteria and governance criteria as having a practical purpose outside of ethical considerations. By following ESG criteria, one can avoid companies whose activities might have signaled that they are at risk and operating in an unsustainable way. For example investment professionals like Morgan Stanley, Morgan Chase, Wells Fargo and Citibank have released annual reports which formally review their ESG approaches and results. While some of those companies include Goldman Sachs, JPMorgan Chase and Wells Fargo that focus on ESG-conscious business practices are increasingly tracking their performance. People are now paying attention to the details of environmental criteria, SRI’s and ethical investing. This means that investors are using the data to ensure that they back the horse which contributes to society in obvious and meaningful ways, while simultaneous making a profit. A potential win win win.
Environmental, Social and Governance Criteria: Cons
On the other hand, ESG is a foolproof plan. It is said that, at the moment, what constitutes ESG is not clearly defined. Sustainable investing takes time, and for the short term SRI’s are equally as vulnerable as any other investment. Investors still need diversity in their portfolios to mitigate that risk. And as ESG standards and criteria continue to evolve, it will reveal that some investments which were considered to be sustainable and ethical, will cease to be. As the sector grows in developed nations, the trustable data for analysis will be slower coming. This makes ESG ranking and scoring for the rest of the world more of a challenge.
How are ESG scores calculated?
ESG scores are Ratings assigned by research companies to individual companies. Bloomberg, S&P, Dow, JYCI Index are major research firms who are tracking some of the well-known ESG companies. They are also creating and refining mission related investing criteria on which to standardize an ESG Score.
ESG Criteria to Evaluate Companies
In general, scores are based on a 100-point scale. The higher the score, the better a company has exhibited its compliance with various ESG criteria. These form the basis of the investment decision making process. The corresponding score can vary across companies utilizing different metrics and weighting schemes to establish an ESG scorecard.
Environmental aspects related to climate change vary from industry to industry, but might include waste management, environmental concerns, supply chain and the company’s carbon footprint. Also, the impact on local communities which are imperative to the global economy. The central factors for social consideration may include annual reports, corporate sustainability measures, resource and employee relations, financial management, board structure and compensation. Governance issues might include executive compensation, accounting transparency and other social criteria which affect the company’s internal environment. It is possible to find guidelines on how to make an ESG report everywhere.
A Wide Variety of Decisions
As we mentioned earlier, there are a wide variety of ESG criteria which govern an ESG score, with a wide variance across all industries. ESG metrics for an Oil & Gas company will differ widely from the ESG integration for an accounting firm or municipality. Companies looking to be added to investment portfolios will need to begin their ESG strategy sooner than later. But it will all boil down to a company’s environmental stewardship, their social impact and how they are governed from within.
Most Popular Insights
A strong business model with ESG can encourage talent retention by instilling a sense of purpose and increase employee motivation. Employee satisfaction correlates positively with shareholder return. The more the employee perceived an employer’s impact on the people they work with, the greater their motivation to act in a positive way. Positive social impact correlates with greater employment satisfaction—when companies “give back,” workers respond with passion. One point by Julian Koelbel, head of research at the Centre for Sustainable Finance and Private Wealth at the University of Zurich was most insightful. He noted: “ESG ratings agencies have, since 2010, become influential institutions. Investors with $80 trillion in assets under management integrate ESG information into their decisions. ESG ratings are the backbone of such investments.”
How does ESG Investing work?
ESG investing is having investments with companies with extremely high environmental, social and governance responsibility scores. This is otherwise known as sustainable investing. ESG Scoring is measured across industry-specific factors of a company’s ESG risk. This could include emissions, environmental product innovation, human rights, shareholders, and other measurements. The ESG considerations are gleaned from publicly-reported data and correlated to form an ESG Scorecard. The theory is that businesses that make enough effort to make stakeholders happy will simply develop well-run business models. In return, these companies become good stocks for sustainable investing. For companies that want a future, ESG investing should be your first priority.
Socially Responsible Investing (SRI)
SRI presents a framework on investors in companies whose values share your social and environmental values. ESG principles are the framework for socially responsible investing which reflect how a firm’s practices and policies have affected profitability and future returns. A SRI is more carefully focused on whether the investment is more in accord with an individual’s values. For example if health and wellness are for you a significant SRI goal can be to avoid investing in companies selling alcohol and tobacco products. A policy in environmental sustainability could be good with investing in alcohol manufacturing as long as the company social and management policies met good standards and their environmental record were strong. So let me say.
Reduced regulatory and legal interventions
Having a strong external value proposition enables a firm to have greater strategic freedom while lowering regulatory pressure. In other words, adopting ESG principles as soon as possible will give your business greater advantage over your competition. Over time, from geographies and segments, we see that the power of ESG investing reduces a company’s risk in government action. In banking where capital requirements are so critical, and where provisions of consumer protection are so great that they are considered too large for failure, the stakes are often 50 to 60. For the automotive industry, aerospace defence and tech sectors where government subsidies are prevalent, this can also reach 60 percent. In the pharmaceuticals and healthcare industries the stakes are 25 to 30 per cent. Nonetheless, it is clear that ESG factors will have a direct impact on sustainability for companies in the future. Therefore, sustainable investing is the now the guiding factor for many investment funds and investment strategies.
Cost reductions with Environmental, Social and Governance
McKinsey advises on ESG and how it reduces ESG risks through operational expenses. ESG can reduce wastage by up to 60 percent according to McKinsey research. Since 1975 3-M has saved $2.2 billion from its program the “pollution prevention payments (3Ps) Program”. FedEx plans to use electric and hybrid engines in its 35,000 vehicle fleet — 20 percent have been replaced. Through lean initiatives a major water utility achieved cost savings of nearly $180 million per year. Other metrics on the relative resource efficiency of companies in several sectors was found, which demonstrated a significant correlation with resource efficiency and financial results. This is the kind of information that excites board members and the public alike. These efficiencies have been a long time coming, and now the pendulum is swinging. We just needed the right motivation to create a sustainable future for all.
ESG issues and Summary
As an emerging and fast growing “industry”, companies and investors are not without ESG issues. Some industries are finding that when it comes to environmental, social and governance, ESG is not without its growing pains. With the advent of some of the worst weather patterns in recorded history taking place around the world, climate change is finally on everyone’s radar. This includes the CFA Institute, is a global, not-for-profit professional organization which promotes standards in ethics, education, and professional excellence in the global investment industry. This includes investment analysis of ESG indexes . And while investment processes rely upon the investor doing the legwork on their own ESG research to screen investments, there is great opportunity for companies and investors alike. And when it comes to climate change, millennial investors will be determining our collective futures.