What is ESG and socially responsible investing?
Today’s investors want their money to fund companies committed to a better world, not just profits.
What is environmental, social and governance investing (ESG) and how’s it different to socially responsible investing (SRI)?
Today’s investors want to invest in companies that do the right things for our planet and the people on it.
Environmental, social and governance investing (ESG) is a strategy used by investors who consider how environmental, social and corporate governance factors affect an investment’s performance in the market – and its returns.
ESG can be confused with SRI, which is an investment approach that considers moral values as well as financial returns. For example, an investor may avoid companies involved in controversial industries such as weapons production and gambling.
SRI is a broader approach that eliminates entire investments based on moral factors. ESG investing looks into how moral factors influence an investment’s performance and return, so a decision can be made on whether to invest.
Let’s explore the three ESG elements in more detail.
What is the environmental factor?
We all know that climate change is widespread, rapid, and intensifying. Action must be taken now. Net zero means not adding to the amount of greenhouse gases in the atmosphere, and governments around the world have committed to being net zero by 2050. Smart companies are with them. The environmental element looks at how companies affect the planet through various factors including renewable energy, greenhouse gas emissions and climate change policies.
Pension firms build strategies for companies to succeed in a low-carbon world. They research companies’ performance against environmental targets and celebrate their successes, but may take investment sanctions against companies falling behind in this field.
What about the social factor?
The social component of ESG covers issues affecting people. How are employees, customers and local communities affected by a company’s actions? Diversity is a key factor: responsible firms employ people regardless of sexuality, gender preference, physical ability, age, ethnic or social background. But the social factor goes beyond this and looks at a company’s ethical sourcing: are its products made responsibly and sustainably? It will look at employee safety policies and sexual harassment prevention, and employee benefits like sick pay and maternity leave. It will look at a company’s mission or higher purpose.
These factors are key to building a company’s reputation and growth. Organisations that reflect the social factor will give their customers confidence, show growth and offer lower risk. And a more diverse company is better placed to make the right strategic decisions.
What is the governance factor?
The governance element looks at how well a company is led. Is a firm being run effectively? Well-run firms keep accounts efficiently and avoid financial problems that could cause job losses, which could in turn damage the wider community. And when those in senior positions aren’t being managed properly, bad decisions can be made, resulting in events as extreme as oil spills that damage the environment.
Business ethics are crucial here too. The governance aspect considers how well a firm a firm treats its employees and discloses its carbon footprint. Boardroom diversity is also important. Less diverse company boards are less likely to use an innovative approach, and ESG investors will want to know that a company is accountable for its actions.
How do investors measure ESG performance?
Corporate reporting can help, and if a firm claims to be ESG-conscious it should publish this information. These companies should produce reports that share their goals and how they’re performing against them. There are independent reports too. And to check on the social factor, sites like Glassdoor publish employee reviews.
Measuring companies’ ESG performance isn’t always easy. A single measurement or score doesn’t always exist. It’s worth remembering there are lots of factors to consider like a product’s carbon footprint, delivery vehicle emissions or employee satisfaction reports. And with a little effort, investors should find this data and base their ESG decisions upon it.
Sources
SRI vs. ESG: What’s the Difference? Yahoo! Finance
What is ESG Investing & What Are ESG Stocks? The Motley Fool
ESG, SRI, and Impact Investing: What's the Difference? Investopedia
What is the difference between ESG investing and socially responsible investing? S&P Global
How to measure ESG Corporate Governance Institute