What Is ESG Investing? (2024)

What Is ESG Investing?

ESG stands forenvironmental, social, and governance.ESG investing refers to how companies score on these responsibility metrics and standards for potential investments. Environmental criteria gauge how a company safeguards the environment. Social criteria examinehow it manages relationships with employees, suppliers, customers, and communities. Governance measures a company’s leadership, executive pay, audits,internal controls,and shareholder rights.

Key Takeaways

  • Environmental, social, and governance (ESG) investing is used to screen investments based on corporate policies and to encourage companies to act responsibly.
  • Many brokerage firms offer investment products that employ ESG principles.
  • ESG investing can help portfolios avoid holding companies engaged in risky or unethical practices.

How ESG Investing Works

ESG investing is sometimes referred to as sustainable investing, responsible investing, impact investing,or socially responsible investing (SRI). To assess a company based on ESG criteria, investors look at a broad range of behaviors and policies. ESG investors seek to ensure the companies they fund are responsible stewards of the environment, good corporate citizens, and led by accountable managers based on criteria including:

  • Environmental: Investors evaluate corporate climate policies, energy use, waste, pollution, natural resource conservation, and treatment of animals. Considerations may include direct and indirect greenhouse gas emissions, management of toxic waste, and compliance with environmental regulations.
  • Social: A company's relationships with internal and external stakeholders are evaluated.Does the company donate a percentage of profits to the local community or encourage employees to volunteer? Do workplace conditions reflect a high regard for employees’ health and safety?
  • Governance: Ensures a company uses accurate and transparent accounting methods, pursues integrity and diversity in selecting its leadership, and is accountable to shareholders.ESG investors may require assurances that companies avoid conflicts of interest in their choice of board members and senior executives, don't use political contributions to obtain preferential treatment or engage in illegal conduct.

ESG investors help inform the investment choices of large institutional investors such as public pension funds. ESG-specific mutual funds and ETFs reached a record $480 billion AUM in 2023.Brokerage and mutual fund companies offer exchange-traded funds (ETFs) and other financial products that follow ESG investing strategies. Robo-advisors including Betterment and Wealthfront have promoted these ESG-themed offerings to younger investors.

Socially responsible investing (SRI) is an investment strategy highlighting one facet of ESG. SRI investors seek companies that promote ethical and socially conscious themes including diversity, inclusion, community focus, social justice, corporate ethics, and racial, gender, and sexual discrimination.

ESG Metrics

Investment firms like Boston-based Trillium Asset Management, use a variety of ESG factors to help identify companies positioned for strong long-term performance. The criteria are set by analysts who identify the relevant issues facing specific sectors, industries, and companies.

Trillium's ESG criteria preclude investments in companies that operate in higher-risk areas or have exposure to coal or hard rock mining, nuclear or coal power, private prisons, agricultural biotechnology, tobacco, tar sands, or weapons and firearms. They do not invest in companies involved in major or recent controversies over human rights, animal welfare, environmental concerns, governance issues, or product safety.

Trillium's metrics include investments in companies that support the environment through renewable energy sources and published sustainability reports. Social metrics include companies that operate ethical supply chains and avoid overseas labor with questionable workplace or child labor policies. Metrics for governance require companies to embrace diversity on the board of directors and maintain corporate transparency.

Investors and ESG

As ESG business practices gain traction, investment firms track their performance. Financial services companies such as JPMorgan Chase (JPM), Wells Fargo (WFC), and Goldman Sachs (GS) publish annual reports that extensively review their ESG approaches and the bottom-line results.

The ultimate value of ESG investing depends on whether they encourage companies to drive real change for the common good, or merely check boxes and publish reports. That, in turn, will depend on whether the investment flows follow ESG tenets that are realistic, measurable, and actionable.

Tobacco and defense are two industries avoided by many ESG investors, but historically produced above-average market returns and can buck recessionary trends. To support ESG, U.S. investors may be sacrificing returns in exchange for values. Many ESG investors are willing to make that tradeoff, though; according to a surveyof Investopedia and Treehugger readers, nearly half of ESG investors said they’d be willing to take a 10% loss over five years to invest in a company that “aligns exceptionally against ESG standards.” But 74% of respondents said that valuation/price was “very or extremely important to them.”

How Is ESG Investing Different From Sustainable Investing?

ESG and sustainability are closely related. ESG investing screens companies based on criteria related to being pro-social, environmentally friendly, and with good corporate governance. Together, these features can lead to sustainability. ESG, therefore, looks at how a company's management and stakeholders make decisions; sustainability considers the impact of those decisions on the world.

What Does ESG Mean for a Business?

Adopting ESG principles means corporate strategy focuses on environment, social, and governance. This means taking measures to lower pollution, and CO2 output, and reduce waste. It also means having a diverse and inclusive workforce, at the entry level and the board of directors.

How Do I Know Which Investments Are ESG?

Several financial firms have ESG ratings and scoring systems. For instance, MSCI has a rating scheme covering over 8,500 companies, giving them scores and letter grades based on their compliance with ESG standards and initiatives. Several other companies, like Morningstar and Bloomberg, have also created criteria for scoring companies on the ESG objectives.

The Bottom Line

ESG investing focuses on companies that follow positive environmental, social, and governance principles. Investors are increasingly eager to align their portfolios with ESG-related companies and fund providers, making it an area of growth with positive effects on society and the environment.

What Is ESG Investing? (2024)

FAQs

What does ESG mean in investing? ›

ESG stands for environment, social and governance. ESG investors aim to buy the shares of companies that have demonstrated a willingness to improve their performance in these three areas.

What is ESG easily explained? ›

What is ESG explained in simple terms? ESG stands for Environmental, Social, and Governance. It is a framework used to evaluate a company's sustainability and ethical impact.

What is the controversy with ESG investing? ›

Critics portrayed ESG investing as primarily motivated by political concerns and a potential drag on returns. Additionally, some critics have raised concerns about the complexity and reliability of ESG metrics.

What is ESG factor investing? ›

ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities.

Does ESG Investing really work? ›

ESG funds have similarities to other funds

While the results from these time periods have been generally encouraging for ESG funds as a whole, we don't see convincing evidence that ESG funds are reliably better than non-ESG funds.

What are the disadvantages of ESG Investing? ›

However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.

Who is behind ESG? ›

The term ESG first came to prominence in a 2004 report titled "Who Cares Wins", which was a joint initiative of financial institutions at the invitation of the United Nations (UN).

What are the 4 pillars of ESG? ›

The Measuring Stakeholder Metrics: Disclosures report reveals the World Economic Forum's performance on four pillars of environmental, social and corporate governance (ESG): Principles of Governance, People, Planet and Prosperity.

Why is ESG a risk? ›

ESG Risks are those arising from Environmental, Social and Governance factors that a company must address and manage. These risks are a combination of threats and opportunities that can have a significant impact on an organisation's reputation and financial performance.

Why are people against ESG? ›

Some opponents also believe that ESG investing is politically motivated and could lead to biased investment decisions.” In a line used by proponents, those in opposition to the ESG movement also believe there is substantial support behind them.

Why don't people like ESG? ›

Critics say ESG investments allocate money based on political agendas, such as a drive against climate change, rather than on earning the best returns for savers. They say ESG is just the latest example of the world trying to get “woke.”

Why did ESG fail? ›

The ESG movement, originally driven by good intentions, has been co-opted by lobbyists, special interest groups and various NGOs, and recent reviews have revealed its lackluster performance in creating meaningful environmental change and have highlighted chronic abuse of flawed methodologies.

How did ESG get started? ›

It refers to a set of metrics used to measure an organization's environmental and social impact and has become increasingly important in investment decision-making over the years. But while the term ESG was first coined in 2004 by the United Nations Global Compact, the concept has been around for much longer.

Why do investors want to invest in ESG? ›

Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.

Does ESG really matter and why? ›

Successful companies are implementing ESG strategies that increase financial, societal, and environmental impact as well as ensure long-term competitiveness.

Why do investors want ESG? ›

Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.

Who started the ESG movement? ›

The UN makes it official

A 2004 report from the United Nations – titled Who Cares Wins – carried what is widely considered the first mainstream mention of ESG in the modern context. This report leaned in heavily, encouraging all business stakeholders to embrace ESG long-term.

Is high ESG good or bad? ›

A low ESG score is relatively poor. Though the scoring and rating scales vary between agencies, a score below 50 is bad, while a score above 70 is considered strong.

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