What is it?
ESG investing is the idea of investing in companies that are better for the environment, society and have responsible management.
Environment
Environment encompasses climate change, carbon emissions, deforestation. Anything that could harm the planet.
Social
Social encompasses slavery, human rights, health and safety, product safety. Anything that could harm society.
Governance
Governance encompasses the management of the business. Is it run ethically, transparently, complying with laws and regulations. Anything to do with people and processes for the management of the business.
The idea is that businesses should be responsible for all the externalities they create, not society. For example carbon emissions that harm the environment should be a cost and problem for the business rather than ignored. Government legislation can help with this as well as societal pressure.
Why ESG?
People choose to invest taking ESG into account for a variety of reasons: they care about the environment and society, they believe high ESG reduces risk or that it increase company performance in the long run. Often with ESG there is more focus on the environment side relating to climate change.
Desire for ethical investing
A large part of the increase in ESG ratings and awareness is people’s desire for ethical investing. They don’t want to keep harming the environment, or use products with dodgy supply chains that exploit people. This demand has fuelled a large rise in ESG funds and a focus on these issues.
Reduced risk
Investing in companies with high ESG may reduce risks to the business. Negative media coverage of oil spills, or humans rights issues negatively affect share prices. Also if there is good management/governance the business may be less open to lawsuits and other issues which could be costly. Having high ESG could help with the longevity and success of the business.
Higher returns?
There is mixed academic evidence as to whether investing in companies with high ESG perform better than those without. As climate change issues become even more important this may change over time.
How to invest with ESG?
There are several ways of investing with ESG. Either keep all industries in and choose the highest ESG scoring companies in each industry. Or to remove whole industries as being unsustainable. Some investment platforms allow you to choose funds of funds, or funds that are ‘compliant’ with high ESG/good for climate change.
Other acronyms are sometimes used for this area of Finance that have similar ethical goals in mind. Some include Impact Investing, Social Investing, Environmental Investing, Socially Responsible Investing (SRI). When investing on platforms look out for these. They may just say ‘good for the environment’ and give you an option. Or you can seek out specific investment funds.
ESG ratings and disclosure
There is no set consensus yet on how to rate companies on ESG nor required disclosures on these issues but legislation is heading that way. Several companies do have rating systems – Sustainalytics, MSCI, S&P.
Finance fighting climate change
Finance can play a huge part in helping reduce climate change, or other social issues. Banks and others can choose whether to fund, or not, companies that decimate the planet, or that harm society. Having increased demand from consumers for high ESG funds etc helps put pressure on Banks and financial institutions to take climate change more into account.
There are various initiatives financial institutions and other companies can sign up to, such as the PRI – Principles for Responsible Investing. This helps encourage companies to adopt the principles and behave sustainably.