What do you need to know about investing in ESG?
Businesses have the potential to impact various environmental, social, and governance (ESG) factors, which can have positive or negative effects on others.
Strong ESG performance can add value to a company’s operations. ESG value creation is not a straightforward transactional process, such as making a sale, but it can bring long-lasting and measurable benefits to businesses. This is why an increasing number of companies are measuring, reporting, and enhancing their actions related to ESG investing criteria.
ESG criteria have become a secret ingredient for investors seeking to build a sustainable investment portfolio because they serve as a predictor of a company’s longevity. It’s worth noting that ESG criteria have interconnected relationships. For example, the governance within an organization that guarantees legal compliance or transparency for company-wide emissions can result in both social and environmental benefits.
Let’s learn how ESG investing works and if it’s a good choice.
What is ESG?
The abbreviation ESG stands for Environment, Social, and Governance criteria, which companies assess within their organizations. The term is used to describe the non-financial criteria that companies use to promote sustainable business practices and value creation.
ESG criteria are designed to benefit society and various stakeholders, including investors, customers, employees, and community members, in ways that go beyond economic gains.
How does it work?
ESG is a voluntary business activity that companies are free to pursue at their discretion. However, many receive specific requests from shareholders or investors for company-wide ESG data releases.
Companies usually share ESG problems with their investors through annual reports, which they make public. The data contained in these reports generally adheres to a set of criteria established by the detailed ESG frameworks and standards adhered to by the company.
ESG investors can utilize the data from ESG reports to assign an ESG rating to a reporting company, allowing them to compare the relative ESG performance of different firms. In addition, third-party providers like MSCI, Bloomberg, and Morningstar may independently assess various companies’ ESG performance for investors’ review.
Certain Data providers compile company scores across various ESG criteria. This allows investors to assess a company’s performance against its rivals.
What is the difference between ESG and CSR?
Environmental, Social, and Governance (ESG) and Corporate Social Responsibility (CSR) are closely related concepts that include corporate reporting on environmental and social impacts. However, there are several key differences worth noting.
ESG investing offer metrics and uniform criteria that investors can use to evaluate a company’s ESG performance. This has resulted in an increase in the number of third-party ESG data compilers, resulting in better reporting consistency across organizations.
CSR actions are not always easily quantifiable into specific metrics or data points that can be compared across a range of companies. This is because CSR is heavily influenced by an organization’s unique mission, culture, and objectives, giving it a more internally significant role.
Companies self-monitor and report on their CSR initiatives and programs, typically hiring their own internal teams to develop and manage their CSR activities. ESG necessitates specific data points and metrics that analysts can use to evaluate ESG performance, often involving external validation.
In summary, the primary differences between CSR and ESG are:
Is ESG investing a good choice?
ESG investing has seen tremendous growth as part of the global sustainable finance movement, surpassing $30 trillion by 2030 – ten times its previous high in 2004.
Research has indicated that businesses with higher ESG rating experience lower business risk, have a strong return on investment, and have long-term viability. These tangible metrics demonstrate why ESG is no longer just a “nice to have” but an integral component of successful business operations.
Research is increasingly showing a correlation between ESG investments and returns. For example, Morningstar released a study in 2019 showing that 41 of its 56 ESG indexes, or 73%, had outperformed comparable non-ESG indexes.
Therefore, ESG-themed ETFs have become a popular option for retail investors seeking to support companies with superior environmental performance.
Nasdaq has proposed a board diversity requirement to the SEC in light of research showing an association between organizational diversity and financial performance. As a result, companies listed on Nasdaq must include at least two diverse members on their boards, one who must be female and the other an underrepresented minority.
ESG investing is part of a broader transition away from passive to active investment styles, with various varieties available. For example, ESG investors may screen investments based on values-based criteria or actively pursue stronger ESG actions through shareholder voting strategies.
As ESG investing continues to gain traction, investors face various obstacles, such as finding high-quality ESG data in standardized formats to enhance their assessments. They may also come across companies that fail to disclose key areas like carbon emissions.