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Fintech & Finserv CX

A Guide To ESG Investing

There's Money on the Table for Companies Paying Attention to ESG

Sustainability is the name of the game for every organization today. Sure, consumers expect the brands they support to be ethical and eco-friendly and governments around the world legislate it, too. But organizations and their investors also understand that their longevity and bottom line depend on sustainable practices.

Through ESG investing, socially conscious investors put their money into companies whose values and practices reflect sustainability. Investors apply three types of criteria – environmental, social and governance (ESG) factors – to evaluate and screen companies for potential investment.

When it comes to successful ESG investing, positive returns include not just financial benefits to the investor, but also positive social, environmental and economic impacts for society.

Growth of ESG investing

ESG investing traces its roots to a 2004 initiative launched by former UN Secretary General Kofi Annan. Annan invited 50 CEOs from major financial institutions to consider incorporating ESG into capital markets. The report from the initiative concluded that ESG investing can support business growth while creating more sustainable markets and positively impacting society. 

In the 15 years since the report, ESG investing has gained traction. While critics initially saw it as a less-than-ideal compromise for investors, since it limited eligible investments and therefore profit, ESG has proven to be more than a passing trend. As savvy consumers demand more transparency from brands, companies are following suit and investment firms are paying more attention to their performance. Major stock markets around the world have sustainability guidelines, including the Principles for Responsible Investment (PRI), launched in 2006 at the New York Stock Exchange. Today, the PRI has over 3,000 signatories and over $100 trillion in assets under management.

 

Why choose ESG?

While it’s true that ESG investing helps people feel good about the businesses they back, the strategy behind ESG goes beyond ethics. It’s also a way for investors to reduce risk in their portfolio by avoiding companies that might one day find themselves paying the price for irresponsible practices. (Think BP’s 2010 oil spill or PG&E’s role in the California wildfires.)

ESG investors won’t support a company that has a bad reputation for polluting a community’s water sources or putting workers in harm’s way. Those kinds of practices aren’t just ethically problematic, they’re also unsustainable and will not  pay off down the road. 

On top of reduced risk, there’s also growing evidence that ESG policies and practices have a positive impact on a company’s long-term financial performance, including talent attraction and retention.

A closer look at ESG factors

A wide variety of considerations are included in ESG investing. Let’s take a look at the three factors in more detail to understand where and how they are linked to companies’ long-term success.

Managing climate change

In ESG investing, environmental factors consider environmental risks an organization may encounter due to their operations. Investors look for companies that follow practices which include:

  • Moderating energy consumption
  • Safely disposing of hazardous waste
  • Minimizing pollution and greenhouse gas emissions
  • Conserving natural resources and using land sustainably
  • Protecting animal welfare
  • Complying with government regulations

Of particular concern to investors today is a company’s stance on climate change and the measures they have in place to minimize their carbon footprint. The PRI notes that climate change is the highest-priority ESG issue for investors, both in terms of protecting portfolios from risk, as well as identifying new opportunities in the low-carbon economy.

Protecting people

Social criteria in ESG investing look at the human side of business, including the extent to which organizations incorporate socially responsible practices related to workers, customers and communities. These include things like:

  • Maintaining safe working conditions
  • Protecting human rights
  • Prioritizing equity and diversity in hiring
  • Promoting employee well-being
  • Supporting the local community
  • Standing up for consumer rights
  • Selecting socially responsible suppliers

While treating employees fairly, fostering equity and protecting human rights are all important on an ethical level, they’re also central to building trust and driving innovation. When workforces support their people in every way, they also create the conditions for productivity, growth and high return on investment. 

Upholding good governance

Governance criteria relate to an organization’s leadership structure, financial management and administration. Investors expect companies to meet requirements such as:

  • Performing honest and accurate accounting
  • Maintaining fair decision-making practices and shareholder voting
  • Avoiding conflicts of interest, corruption and abuses of power
  • Following the law

Governance issues like tax avoidance and corruption present high levels of risk for investors. ESG investors want to know that the companies they invest in have strong and transparent governance that won’t pose a threat to returns.

ESG standards and guidelines

It’s virtually impossible for a company to check off all the sustainability boxes. That’s where investors’ personal values come in. Investment firms offering socially responsible portfolios must also establish their own priorities for identifying eligible organizations.

Sustainability reports help investors understand businesses’ impact on critical sustainability issues, such as climate change, human rights, governance and social well-being. Companies report on their sustainability practices using standards such as those set out by the Global Reporting Initiative (GRI), which is used by 80 percent of the world’ largest companies. The International Integrated Reporting Initiative (IIRC) and Sustainability Accounting Standard Board (SASB) are other organizations that play a role in improving the quality of ESG information for investors.

Investors can also access ESG index ratings that provide benchmarks and track the performance of companies that meet ESG factors. According to iShares, today there are upwards of 1,000 ESG indexes, which is proof of a growing appetite for ESG products and tools to guide investor decision-making.

One such index is the MSCI KLD 400 Social Index, a capitalization-weighted index of 400 publicly-traded companies with high ESG ratings. The index delivers a diversified benchmark, while excluding companies involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, GMOs and adult entertainment. The MSCI KLD 400 Social Index has historically performed as well as, or better than, the S&P 500 Index, with a difference ranging from +8.19 to -3.73 percent over the past 10 years. These numbers suggest that investors don’t have to sacrifice financial returns in order to invest in sustainability.

In many ways, the rise of ESG investing is a reflection of how societal values are shifting. And as ESG continues to grow in importance, companies’ future success is increasingly dependent on having a continuously evolving sustainability strategy that reflects green, socially responsible and transparent business practices.

 


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