What Is ESG Investing?

Photo by Karsten Würth on Unsplash

ESG means Environmental, Social, and Governance.

It is a set of criteria that some investors use to decide whether or not to invest in a company.

The environmental criteria look at how sustainable the company is, and what its impact on the environment is; the social criteria look at how the company engage with its employees, suppliers, and customers; and the governance criteria look at how the company is managed.

ESG investing is sometimes referred to as sustainable investing, or impact investing.

A Short Story of ESG

While ESG formally appeared in 2006, its roots go back to the 18th century in America.

At the time, the Methodists, a group of Christian Protestants, decided to stop investing in companies that they deemed negatively impacted society, such as tobacco, gambling, alcohol, or armament companies.

The first fund ruling out “sin industries” was started in Boston in 1928.

These principles evolved and were brought up to the forefront in 1960 during the Vietnam War, when students demanded that universities stop investing in armament companies.

This type of investing took the name of Socially Responsible Investing (SRI), the ancestor of ESG.

SRI was quickly extended to avoid companies dealing in war, apartheid, and to support fair trade and other impactful practices.

The term ESG first appeared in a rapport called Who Cares Win. This rapport had been suggested by the then UN Secretary General Koffi Annan to twenty financial institutions.

The purpose was to analyze how investors and institutions could invest their money not only for profit, but to encourage positive change in society.

According to the report, ESG practices will win in the long term due to the significant value delivered to shareholders on one hand, and the impact on branding and society on the other.

Several initiatives have since then been developed at the governmental level to encourage more and more companies to focus on ESG.

ESG Criteria

Environmental

The environmental criteria relate to everything related to the environment, such as:

  • Direct and indirect CO2 emissions
  • Energy use
  • Pollution
  • Resources consumption
  • Recycling practices
  • Animal welfare

The more respective of the environment a company is, the highest it rates on the environmental criteria of ESG.

Social

Social aspects look at how companies treat their internal and external stakeholders.

These stakeholders are the employees, the customers, the suppliers, and anyone else impacted by the company’s activity, such as local communities in some cases.

The social aspect ensures that the company has high standards for diversity and inclusion, for example, that the company practices equal pay, and that it fights against all types of discrimination.

Governance

The governance criteria relate to the actions the company takes to lead as well as how it engages with its shareholders.

Is the accounting transparent? Does the company hire and pay lobbyists? Does it fund political parties? Does it lie, hide things, or engage in unethical behaviour?

The governance criteria analyze how ethical and transparent the governance of the company truly is.

Advantages

ESG investors ensure that the companies they invest in won’t suffer from scandals due to the natural inclination of ESG criteria to focus on ethics and impact.

Furthermore, these investors can also have a good conscious knowing that the companies they have invested in are improving their practices and doing good both for the planet and society.

Disadvantages

Historically, “sin industries” that ESG investors don’t invest in have delivered more returns than ESG industries.

Furthermore, ESG does not necessarily equal returns. Many ESG companies have lost money, and the investing giant Blackrock has halved ESG investing since the beginning of 2022.

Conclusion

ESG allies both investment and positive impact on society.

It’s a great tool for mindful investors that want to make sure their money is used to a good end.

Sources:

Investopedia

Forbes

Forbes

NPengage

Investopedia

IFC

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