What Is Environmental, Social, and Governance (ESG) Investing?

What Is Environmental, Social, and Governance (ESG) Investing?

Let me explain ESG investing directly: it stands for environmental, social, and governance, and it's an approach where you evaluate companies for investment based on how they perform in these areas. You look at environmental factors to see how a company protects the planet, social aspects to check their relationships with employees, suppliers, customers, and communities, and governance to assess leadership, pay structures, audits, controls, and shareholder rights.

Key Takeaways on ESG Investing

Here's what you need to know: ESG investing screens investments using corporate policies to push companies toward responsible actions. You'll find many brokerage firms offering products built on ESG principles. This method helps your portfolio steer clear of companies involved in risky or unethical practices.

How Environmental, Social, and Governance (ESG) Investing Works

You might hear ESG called sustainable investing, responsible investing, impact investing, or socially responsible investing (SRI). When you assess a company with ESG criteria, you examine a wide range of behaviors and policies to ensure they're good stewards of the environment, solid corporate citizens, and run by accountable leaders.

On the environmental side, you evaluate things like climate policies, energy use, waste, pollution, resource conservation, and animal treatment, including emissions, toxic waste management, and regulatory compliance.

For social criteria, you look at how the company handles relationships with stakeholders—do they give back to communities, encourage volunteering, or prioritize employee health and safety?

Governance ensures accurate accounting, integrity in leadership selection, diversity, and accountability to shareholders, avoiding conflicts of interest, undue political influence, or illegal activities.

As an investor, you can influence large institutional players like pension funds through ESG. By Q4 2024, sustainable funds hit $3.2 trillion in global assets under management, per Morningstar. Brokerages and mutual funds provide ETFs following ESG strategies, and robo-advisors like Betterment and Wealthfront target younger investors with these options.

Important Note on SRI

SRI is a specific strategy within ESG that focuses on companies promoting ethical issues like diversity, inclusion, community focus, social justice, and corporate ethics.

ESG Metrics

Firms like Trillium Asset Management use ESG factors to spot companies set for long-term success, with analysts tailoring criteria to sectors and industries. They seek positives like reducing pollutants, using renewables, fair wages, ethical supply chains, diverse boards, and transparency. They avoid investments in companies deriving 5% or more revenue from coal mining, gambling, tobacco, private prisons, or weapons, or those in major controversies over human rights, animal welfare, environment, governance, or product safety.

Investors and ESG

As ESG practices grow, investment firms track performance, with companies like JPMorgan Chase, Wells Fargo, and Goldman Sachs issuing annual reports on their ESG approaches and results. The real value of ESG depends on whether it drives genuine change or just superficial reporting, hinging on realistic, measurable, and actionable tenets.

Industries like tobacco and defense, often shunned by ESG investors, have historically delivered strong returns and resilience in recessions. You might sacrifice some returns for values, but surveys show nearly half of ESG investors would accept a 10% loss over five years for strong alignment, though most still prioritize valuation.

What Does ESG Mean for a Business?

For a business, adopting ESG means integrating ethical policies into strategy, such as reducing pollution and emissions, community giving, and maintaining diverse, inclusive teams from entry level to the board.

How Is ESG Investing Different From Sustainable Investing?

ESG and sustainable investing are related but distinct: ESG screens for social justice, environmental concerns, and governance, leading to sustainability, while sustainability focuses on the broader impact of decisions on the world.

How Do I Know Which Investments Are ESG?

You can check ratings from firms like MSCI, which scores over 17,000 companies with letter grades on ESG compliance as of June 30, 2024. Other providers like Morningstar and Bloomberg offer similar scoring systems.

The Bottom Line

In summary, ESG investing targets companies adhering to positive environmental, social, and governance principles. As an investor, you're increasingly drawn to aligning portfolios with these, boosting growth in this area with benefits for society and the environment.