What is ESG Investing? Short Overview

Today’s investing landscape extends beyond mere financial gain and addresses crucial pain points affecting the modern world. As we grapple with global warming, social inequality, and unfair corporate policies, investors have adopted forward-thinking investment strategies that raise significant returns while simultaneously addressing contemporary issues.

ESG investing presents a paradigm shift from conventional, money-centric investing to investing centred on social responsibility and engendering positive impact. Progressive investors strongly believe that companies with solid ESG policies are better positioned for long-term success and have an edge over their competitors.

Join us as we explore everything you need to know about ESG investing, including what it means and its implications for investors, businesses, and consumers. Without further ado, let’s dive straight into it.

ESG Meaning

ESG means Environmental, Social, and Governance. You can think of it as a set of policies, practices, and metrics that investors and interested parties use to gauge a company’s well-being and stability beyond fiscal matters. Investors, regulatory bodies, consumers, and analysts use this framework to understand a company’s stance on issues influencing global dynamics.

While ESG has little to do with balance sheets and profits, it profoundly influences a company’s current and future financial standing. Contrary to skewed public opinion, ESG is much more than a short-lived craze overhyped by the media. Far from that, it’s a global push for ethical and sustainable business practices and a blueprint for the future of world business.

That said, ESG, as the name implies, consists of three main components: Environmental, Social, and governance. These three facets collectively create the architecture for assessing a company’s performance and impact. Below is a brief breakdown of these elements.

Environmental

The “E” in ESG denotes Environmental, which highlights a company’s or organisation’s environmental considerations. It delves into corporate policies on crucial aspects of eco-sustainability, including:

• Energy use
• Waste management
• Conservation of natural resources
• Pollution and Emissions
• Treatment of animals 
• Environmental regulations compliance

Social

“S,” on the other hand, stands for social. Here, a company’s relationship with society at large is put under scrutiny. It answers questions like, “How does the company treat its employees, suppliers, and customers?” and “What has the company done for the local community?”. Key considerations on the social front include:

• Workforce inclusivity
• Racial diversity
• Pay equality
• Hiring procedures

Governance

Lastly, we have “G,” an acronym for governance. Governance delves into a company’s standard operating procedures. It examines how a company runs and ensures checks and balances for ethical behaviour. Some notable elements of governance in ESG are:

• Transparency and accountability
• Board oversight (leadership and management)
• Board composition
• Whistleblower policies
• Financial integrity
• Incentives and compensation policies

Governance is arguably the most important aspect of ESG since it’s the starting point and driver of everything else. Protocols on green practices, recruitment exercises, and accounting procedures all begin with the company’s executive. Governance thus sets the tone for how the organisation handles everything else.

It’s also difficult to overlook the profound influence of the younger generation as wealth transitions to the younger ilk in the next decade or so. According to Nasdaq, about two-thirds of millennials and 82% of Gen Zers are exposed to ESG investments. Companies keen on capitalising on the younger democratic have shifted their efforts towards ESG initiatives, with promising results. It’s likely that ESG investments will take centre stage in the future.

While ESG investing is undoubtedly a hot-button issue, most people mix it up with sustainable investing, a different but closely related form of investment. While ESG investing anchors on the key tenets of environmental, social, and governance, sustainable investing is much broader, involving other aspects of sustainability like climate and impact investing. 

How ESG Investing Works

With ESG meaning out of the way, let’s look at how investors leverage ESG to make propitious investment decisions. As ESG gains traction, investment firms and individual investors prioritise ESG-compliant companies.

Investors closely monitor annual reports from financial services like Goldman Sachs and JP Morgan on how they approach ESG and what objectives they aim to achieve. What’s more, third-party agencies like Bloomberg ESG and Sustainalytics review organisations and their fund disclosures and give an ESG score. Companies struggle to keep up with ever-changing ESG standards, but the crux is whether they orient themselves toward driving real change for the better.

Professional fund managers compile investment portfolios under strict criteria, limiting their investments to company stocks and financial instruments that meet these criteria. ESG adds another threshold for these managers, where they’ll be unwilling to invest in companies that don’t prioritise ESG, and rightly so.

The growing awareness of ESG has led to the proliferation of ESG funds, which are investment vehicles fund managers use to allocate capital to ESG-compliant initiatives. Companies with higher ESG scores will likely receive more financing, giving them a competitive advantage over their peers.

However, this begs the question, “How do agencies calculate ESG scores?“

The calculation of ESG scores has been a bone of contention ever since ESG came into the limelight. While Environmental, Social, and Governance are broad-based aspects of the concept, the finer details separate companies looking to really make a difference from those in it for profit.

That said, the world has yet to establish a single regulatory body and framework for determining ESG scores. Unsurprisingly, this throws a spanner in the works and creates a leeway for deceit and corruption. With more than a dozen frameworks adopted to determine ESG scores, the objectivity of these scores remains up to question. However, the FCA requires all claims on ESG to be “reasonable and substantiated.”

This murkiness on ESG scores has put professional fund managers in limbo as to how to evaluate ESG core accurately. Most would rather hedge their bets with data providers than rely solely on third-party agencies. For instance, they can use MSCI’s rating system, which ranks organisations from AAA to CCC (best to worst). The MCSI uses data from government databases, research institutions, and public company disclosures to rank companies.

Benefits of ESG Investing?

Bloomberg’s projection for ESG funding may top $53 trillion by 2025. ESG presents a golden opportunity for investors to make a serious killing while making the world a better place. Companies readily embracing ESG also benefit from improved internal operations and enhanced public perception. Below are some of the key benefits of ESG investing.

1. Better Portfolio Management

It’s safe to say that ESG companies outperform non-ESG ones by a considerable margin. ESG investments top most fund managers’ portfolios, and the trend will likely push on into the future.

High ESG scores are more than cosmetic figures but demonstrate a company’s fiscal management and overall stability. ESG companies must implement robust financial and governance policies to meet ESG standards. Plus, part of the environmental aspect of ESG involves embracing energy-efficient technologies, which translate to cost reductions and increased profit margins.

2. Enhanced Risk Reduction and Management

Strict criteria and safeguards dictate ESG investing, which helps reduce the likelihood of risky investments. As mentioned, ESG companies are more future-proof than non-ESG ones. That’s because ESG companies keep tabs on the latest ESG standards heavily shaped by consumer and global trends.

An ESG investment strategy singles out companies with responsible business practices and positive public relations. Such companies are less likely to encounter compliance and regulatory issues. They enjoy a consistent stream of customers and sponsorship from global companies whose values align with theirs.

ESG companies are also cushioned from hidden risks common with changing regulations on the environment, social equity, and other similar factors. By investing in ESG, you can rest easy knowing your investment is safe.

3. Supports Environmental Sustainability

Voracious capitalism has put our planet on the precipice of a climate disaster, with manufacturing companies producing 0.6 billion metric tons of carbon emissions in 2021 alone. This is incredibly detrimental to the environment and threatens biodiversity while exacerbating global warming.

ESG companies are committed to promoting environmental sustainability by using renewable energy sources and sourcing raw materials from environmentally responsible suppliers. They also actively participate in green initiatives like reforestation drives and waste reduction exercises. By investing in these companies, you’ll be indirectly playing your part in promoting environmental sustainability for a better tomorrow.

4. Promotes Innovation and Adaptability

The ESG buzz has ushered in a new age of innovation. An almost unprecedented skyrocketing demand for eco-friendly products has put companies on their toes. Businesses are looking to cash in on this growing demand. So, it’s no surprise they’re heavily investing in innovative eco-friendly products, which is a double win. The first win is that it fosters ecological sustainability, and the second win secondly is how it increases competitiveness among businesses, translating to better products for the consumer.

ESG standards have also compelled companies to adopt more prudent ways of utilising natural resources. This resourcefulness has enabled ESG companies to reduce waste and develop effective waste management procedures. They’ve also innovatively broken new ground in terms of energy saving and adopted efficient cost-cutting measures on their day-to-day operations.

5. Attracts Skilled and Passionate Talent

One of the social benefits of ESG investing is promoting an inclusive workforce and a conducive environment for employees. Thanks to ESG, businesses are now, more than ever, taking a keen interest in their workers’ well-being. For instance, company executives are now implementing policies that allow staff members to have a proper work-life balance. This includes flexible working hours and the opportunity to work remotely.

In doing so, these companies attract and retain competent employees who love working for their companies. Employees also work in better environments and are more likely to work conscientiously and hit their targets. This is not only beneficial to the company but also to the employees’ well-being, with greater job satisfaction and fewer instances of burnout.

6. Better Regulatory Compliance

Compliance with various regulatory agencies is a headache for companies and business owners. You see, companies have to contend with constantly changing standards and regulations. This is hard for some businesses and organisations to keep up with, especially smaller companies that don’t have the luxury of hiring in-house compliance teams or legal experts to check all compliance boxes.

Fortunately, contemporary regulations mostly align with ESG values since they’re anchored in progressive ideas like promoting environmental sustainability, ensuring fair and transparent business practices, and advocating for solid leadership. 

This makes it less likely for companies to breach regulations by environmental agencies and regulatory bodies. Organisations and businesses will inadvertently find themselves in compliance with these regulations without coercion.

Challenges of ESG Investing

While ESG investing is immensely beneficial, it’s not all sunshine and rainbows. Both companies and investors encounter considerable ESG investing hurdles that they must overcome. Some of these challenges include:

Final Thoughts

ESG investing is an excellent way to promote social equity, ethical practices, and green practices and make money while doing so. Nowadays, business success isn’t solely about profit but also about aligning with progressive values centred on making the world a better place. While ESG investing has its challenges, governments and regulatory authorities are working on structures to harmonise ESGs.

Hopefully, with definite standards and proper regulations, non-ESG companies will hop on the bandwagon and usher in a new age of sustainable business practices and social responsibility, transforming the corporate world from a money-milling machine to a paragon of ethical stewardship and positive impact.