A Guide to ESG Investing
If there was ever doubt over why investments should consider environmental factors, it has been obliterated by our shifting global climate. Severe drought, rising ocean temperatures, and extreme weather are more obvious every day. The same can be said for social factors. Food insecurity and hunger, extreme poverty, discrimination, and—as our current pandemic unveils—unstable health care systems plague humans across the globe. These issues are ingrained in modern human existence.
What comes from this is where and how to effectively create change. What are the ways that we, as citizens living on a hurting planet and amid a challenged global population, can be impactful? How can we think differently in how we consume, spend, support, and exist so that our actions work to help solve these issues? In the schism between wellbeing and distress there is great possibility.
One of the most profound ways to create impact is our North Star at The Conscious Investor: How we spend and invest our money has the potential to change the world. Growing research shows that more and more people are considering environmental, social, governance (ESG) and ethical factors when devoting their capital toward an endeavor. Rather than merely looking at the potential financial returns, investors are increasingly cognizant of the actions that companies make. There is a deepening awareness of how every investment has the potential to make an impact. The result is a demand for socially responsible investment opportunities that integrate ESG criteria. Where and how we put our money has the power to make a difference.
However, with any burgeoning field comes a new lexicon. Within the world of investing that gives credence to ESG factors, there are some terminologies that are often used interchangeably. One common question we come across pertains to confusion between ESG and impact investing. Is ESG impact investing? Let us unpack it for you.
Firstly, what is ESG?
Environment, Social, and Governance (ESG) Investing is an investing approach that considers all the factors in its name during the investing process. Before moving capital, the investor (or manager) will thoroughly look at the company's stance toward 1.) the environment 2.) people and 3.) governance to see how those will impact the investment performance. While there is a strong ethical component, as well as a drive to do good, the main objective of ESG is to use these criteria to evaluate the best potential financial achievement, to find potential negative aspects of a company, and to screen out those risks. Sustainable development goals (SDGs) and other impact criteria are not considered with ESG.
What do the E, S, and G really cover?
Environmental: These factors look at how a company honors—or doesn't honor—the environment in its practices. They can include how it works to conserve energy and reduce its output of waste, how it considers the use of toxic or pollutive substances, how it designs its packaging, the means of transportation it uses, and how it future-proofs against further climate change effects.
Social: The S component takes into consideration how a company's processes affect the people involved—i.e. the employees. Does the company take into consideration the health of its employees? Does it offer fair pay, encourage an inclusive and positive culture, and growth opportunities? Or do the company's goals deteriorate the wellbeing of those working to bring it to fruition? This is where a closer look at inequality, child labor, and other instances of abuse come into focus.
Governance: Lastly, the G looks at leadership and practices. How a company is run, from its board inclusion to its C-level executives’ strategies, has immense impacts on its other factors. Governance also takes into account if a company has had a history of illegal or unethical activity.
Why is ESG important?
ESG is a promising framework for at least two reasons: It pushes the tide of good by encouraging investing in companies that are considering these essential factors. It also has been looked at as a way to mitigate financial risk, as research shows there to be a link between successful company performance and strong ESG attributes. In essence, ESG offers investors a new set of standards to consider that surpass traditional statistics and trends.
When making an ESG investment, some will look to third-party independent rating agencies to assess risk and potential. MSCI is one organization that delivers specific ESG insights, as well as evaluations on how a specific company compares to its peers within an industry. (MSCI also looks at how a company scores according to any controversial activities, like involvement in the gambling or weapons industry.)
Community investing is an important segment of ESG, which aims to finance endeavors that serve underserved or marginalized communities, according to the Forum for Sustainable and Responsible Investment.
How is it unique to impact investing?
Let us first take a brief look at impact investing: Impact investing is investing with a specific intention to generate measurable positive social, ethical, and environmental impact alongside a financial return. With impact investing, the goal to produce a positive impact is absolute—meaning, it's as (or some may argue more) important as the financial return. (Research shows impact investments deliver on these returns—or outperform expectations—at least 90 percent of the time.) Impact investing has become mainstream with potential for tremendous growth across most asset classes as it continues to demonstrate investment value.
As we've written about before, impact investments tap into a way to tackle the critical issues hurting ourselves and our planet, such as affordable healthcare, housing, education, renewable energy, and sustainable agriculture. (Impact investments look to make an impact on the UN’s seventeen Sustainable Development Goals.) The global challenges of today demand sustainable and profitable solutions. Impact investors look to the companies creating a measurable difference, like Kasha, an e-commerce company that is making health and personal care products accessible to women in East Africa. A thematic approach is often taken by impact investors, which includes a set of strategies and specific objectives that add up to the greatest potential impact.
With ESG, the environmental, social, and governance factors offer additional ways to view the investment and its potential, however an intention to produce measurable good may be strong, but it is not an absolute like it is with impact investing. ESG allows investors to better screen for companies that are adapting to the needs of the present and the future. It takes into consideration a company's inner workings and actions rather than the product or impact.
Some view ESG and impact investing as two unique ways of investing. We view ESG as a sub-category of impact investing rather than its own category. Think of impact investing as a large “umbrella under which ESG, private investments, green real estate, forestry, green bonds” and more live, says Beyond Capital co-founder, Eva Yazhari. “In other words, it is not one asset class,” she continues, “and any asset class can be viewed through the impact lens.”
When did ESG originate?
The impetus behind the ESG movement is credited to the late former Secretary General of the UN Kofi Annan. A passionate advocate for global education and sustainability, Annan ignited a conversation about sustainable investing in a changing world when, in 2004, he invited more than fifty global financial industry leaders to discuss pressing ESG issues. (This initiative was part of the UN Global Compact, a citizen pact formed in 2000 that encourages global businesses to adopt socially and environmentally sustainable practices.) Annan and financial experts threw themselves into intense conversations and research that resulted in the report Who Care Wins, a detailed thesis of why and how ESG is critical. "Endorsing institutions are convinced that a better consideration of environmental, social and governance factors will ultimately contribute to stronger and more resilient investment markets, as well as contribute to the sustainable development of societies," the report reads. This ultimately led to the founding of the UN-backed Principles for Responsible Investment, a framework that works to encourage investors to consider ESG.
Does ESG make enough of an impact?
Of course, this depends on the investor and their goals and strategy. For Yazhari, it is a vital sub-category within her impact portfolio, but not the entire picture. “My view is that it is a piece of the puzzle, not the whole solution,” she says. “For example, without Beyond Capital, ESG would not be enough for my portfolio, but it meets certain goals, and the two balance each other out.”
Once again: ESG investing is about negatives and screening out those negatives based on risk—and SDGs are not considered. Impact investing is about value creation—catalyzing action by investing in sustainable, profitable businesses that measurably advance their communities, make a positive impact, and provide long-term value to their market.
Interesting ESG Performance Statistics, Resources, and Further Reading
A March 2020 article from the Wall Street Journal focuses in on how the COVID-19 outbreak has highlighted the importance of ESG factors. “The pandemic has demonstrated the importance of other factors that are paramount to ESG investors. Among them: disaster preparedness, continuity planning and employee treatment through benefits such as paid sick leave as companies direct employees to work from home.”
Impact investments rise amid the Covid-19 pandemic, as stated in the Barron’s magazine, PENTA. “Investors who care about creating a positive impact have been stepping up to finance companies directly involved in addressing the coronavirus pandemic and to make sure others doing important work have the cash to keep going.”
“Better governance, active engagement, and smarter stock screens can help boost returns,” according to this recent Financial Times piece.
A 2019 BlackRock Investment study shows that ESG portfolios can be more resilient in downturn scenarios, which suggests the strength behind factors such as good governance, resilient supply chains, and environmentally sustainable business practices.
In this report from State Street Global Investors, nearly 70 percent of ESG investors stated that these investments helped them manage volatility.
Morningstar finds that sustainable investment funds are weathering the coronavirus correction better than most funds.
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At The Conscious Investor, it is our goal to shed light on topics that we find interesting, inspirational, and educational. Therefore, this article is strictly for inspirational and informational purposes only. It is in no way intended to substitute for professional investment advice, professional financial advice, or general counsel. To the extent that an article features the insight, opinions, or advice of an expert or company, the expressed views are those of the cited person or company and do not necessarily represent The Conscious Investor and its employees or affiliates.