Socially responsible investors tend to evaluate businesses on financial performance, but with the pandemic having all but destroyed the global supply chain, and the rush to divest from Soviet oil, ESG factors have been catapulted to the front of the line for assessing investments. And although sustainability has been on the radar of companies and investors for years, the last 18 months have increased the awareness of our vulnerability. The effects have become glaringly obvious both socially and environmentally all around the world. We are quickly coming to realize that it is no longer “us and them”, but “us and us”. Environmental, social and governance are the principles on which our future will be measured in business. This article will help you to define ESG investing realities.
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. So, brace yourself, because by the end of this article you will be the local expert on transitioning to a sustainable circular economy.
What is an investor in ESG?
First of all, we need to establish what an “investor” is. We tend to think of investors as people buying & selling stocks on the markets. But the definition is expanding to encompass anyone who has a stake in the sustainability of a business. This includes consumers, employees, suppliers, communities and the environment.
An ESG investor is someone who proactively seeks out businesses which create social & environmental value, in addition to financial returns. In other words, they are looking for companies which are “doing good” as well as making money. We need more of these in the world!
Good question. ESG can be broken down into three key pillars:
Environmental – looking at a company’s carbon footprint, water usage, waste & pollution
Social – assessing how they treat their employees, local communities & customers
Governance – transparency & accountability in leadership & management
Each of these factors is important in its own right, but they are also interconnected. For example, a company with strong environmental practices is most likely to have good social & governance policies too. Whereas a company with poor governance standards will have shortcomings with its environmental and social aspects because of weak leadership. It’s like a three legged stool. If you take away one of the legs, the stool is of little benefit.
What are environmental, social and corporate governance assets?
Whereas business have been measuring and analysing their financial assets for centuries, ESG measures intangible assets in a company. For instance, lets take a look at how a company’s water usage might be an ESG asset.
Water is essential for life, but it’s also becoming increasingly scarce. In fact, by 2025, it’s estimated that 1.8 billion people will live in countries with severe water shortages. This will have a major impact on business, particularly those which rely heavily on water for their operations.
Companies which are proactive about their water usage will be in a better position to withstand these shortages. They will also be viewed favourably by investors who are taking ESG factors into account. As such, water usage is an important ESG asset for companies to measure and manage future risk.
What if they don’t make their water supply sustainable?
If they do not find ways to ensure their water supply, then they are at risk becasue there are only a limited number of potential outcomes. For example:
- It could drive up their production costs
- They could be fined
- Their reputation could be damaged
- They could lose their license to operate
- They could go out of business
These are all risks which could have a major impact on the financial returns of the company. And this is why investors are increasingly interested in companies which are managing their ESG assets effectively.
What are the benefits of the ESG criteria?
It is well proven that companies which manage their environmental, social and governance assets effectively are more profitable and resilient in the long-term. This is because they are able to anticipate and manage risk better than their peers.
In addition, ESG criteria can be used to identify companies which are innovators and leaders in their field. These are the companies which are developing new products and services which will be in demand in the future.
And finally, ESG investing is a way to align your values with your investment portfolio. This is becoming increasingly important for investors as they seek to make a positive impact on the world through their investments.
What are some of the challenges of ESG criteria?
Some of the challenges of ESG criteria include:
Data availability – There is a lack of consistent and reliable data which makes it difficult to compare companies across different sectors.
Data quality – Even when data is available, it is often of poor quality which limits its usefulness.
Standardization – There is no globally accepted set of standards for measuring and reporting ESG data. This makes it difficult to compare companies on a like-for-like basis.
Time & effort – Collecting and analysing ESG data is time-consuming and resource-intensive.
Despite these challenges, the benefits of ESG investing are clear. And as more investors become interested in this area, we can expect to see greater progress in terms of data availability, quality and standardization.
How are ESG scores calculated?
Although the first attempt to measure and quantify ESG scores on environmental, social and governance factors was in the late 1970s, it has only been in recent years that they have become widely used by investors.
Today, there are a number of different providers of ESG data and ratings. These include MSCI, Sustainalytics, Bloomberg and Thomson Reuters.
Each provider uses its own methodology to calculate ESG scores. However, they all follow a similar process which involves four steps:
1. Identify the issues which are material to the company’s performance.
2. Collect data on those issues from a variety of sources.
3. Analyze the data to arrive at a score or rating.
4. Monitor the company’s performance on an ongoing basis.
What are the ESG criteria to evaluate companies?
In general, scores are based on a 100-point scale. They calculate the company’s performance on each of the three dimensions of ESG (environmental, social and governance) relative to its peers. The higher the score, the better the grade.
However, there is no globally accepted set of standards for measuring and reporting ESG data. This makes it difficult to compare companies on a like-for-like basis. Apples to apples and oranges to oranges. But there is enough data being collected to at least get an idea od the ballpark comparisons across a number of industries. There is more to come, and it is coming fast. You may want to check out our guidelines on how to make an ESG report.
What are some common misconceptions about ESG criteria?
There are a number of common misconceptions about ESG criteria.
1. ESG is a fad – This is simply not true. Interest in ESG investing has been growing steadily for many years and there is no sign of it slowing down.
2. ESG investing is only for large institutional investors – While it’s true that many large institutions are now incorporating ESG criteria into their investment decisions, this is not limited to them. In fact, there are a number of products available which allow retail investors to access this type of investing.
3. ESG investing is only for “socially responsible” investors – Again, this is not the case. While some investors do choose to invest in companies which they believe have a positive impact on society, this is not the only reason to consider ESG factors. Many investors simply believe that incorporating ESG criteria into the investment decision-making process can lead to better financial outcomes.
4. ESG investing means sacrificing returns – This is a misconception which has been completely debunked as more and more evidence emerges that ESG investing can actually lead to better financial outcomes.
What is an ESG strategy?
Strategies around ESG investing are becoming more common as investors seek to align their values with their portfolios.
- One way to do this is to invest in companies which are leaders in environmental, social and governance practices. This is often referred to as “impact investing”.
- Another approach is to integrate ESG criteria into the investment decision-making process. This means considering ESG factors alongside financial considerations when making investment decisions.
- A third approach is to exclude certain companies or industries from the portfolio on the basis of their ESG performance. For example, many investors now choose to avoid investments in companies which are involved in the production of tobacco or weapons.
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.
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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 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.” This is a bit dated, but last year there were over $330 billion under management for ESG related 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 reporting 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.
What is the ESG investing definition?
ESG investing is an approach to investing that takes into account environmental, social and governance factors. It aims to create long-term value by considering how a company’s activities impact people, planet and profits. The goal of ESG investing is to generate sustainable, long-term value for investors. ESG definition investment.
What is the ESG meaning finance?
The definition of ESG in finance is environmental, social and governance. It refers to the three central factors in measuring the sustainability and ethical impact of an investment.
In conclusion on whats ESG & ESG factors definition
In conclusion, ESG is a broad concept that is being applied to many different industries in order to promote sustainability. It is still early days, but the potential for cost savings, increased efficiency, and reduced risk are all very promising. As more companies adopt ESG principles, we can expect to see even more positive results.