The Ins and Outs of ESG Investing in 2022
Masterworks These days, investors want more than just companies that deliver strong returns. They want companies that do their part to take care of the Earth—and they’re willing to put their investment dollars to use for it.
For example, did you know that over $3.4 billion in institutional equity was invested in sustainable open-end funds or ETFs in the fourth quarter of 2020? Or that 21% of investors expressed an interest in ESG investing?
What is ESG investing? And is it the right fit for your investment dollars? Here’s what investors should know.
What is ESG Investing?
ESG investing, or Environmental, Social, and Governance investing, is a specialized subset of investing that focuses on socially responsible investing. It prioritizes the company’s financial returns alongside its impact on the environment and the planet.
This has become particularly important to investors over the course of the COVID-19 pandemic, as companies with strong ESG performance showed lower volatility overall.
Environmental performance impacts things like a company’s carbon footprint, greenhouse gas emissions, renewable energy usage, and so on. Social performance deals with the company’s relationship to its employees, stakeholders, and larger community, focusing on issues such as employee treatment, diversity practices, inclusion training, ethical supply chain sourcing, and stance on social justice issues. Lastly, governance has to do with the company’s leadership and business ethics, including executive compensation, how decisions are made, and diversity within the executive management team.
ESG vs CSR vs SRI
While ESG, CSR, and SRI are often used interchangeably, they refer to slightly different things.
Corporate social responsibility, or CSR, is a business practice that attempts to improve the local community, the environment, or society. Aside from strengthening the company’s mission, these initiatives are often an excellent PR boost.
Socially responsible investing, or SRI, is a more general term which ESG can be classified under. Many socially responsible investments are graded as such based on ESG performance metrics.
Of the three, ESG is the most defined as an investment avenue. While SRI excludes certain investments, such as tobacco, ESG offers a way to prioritize companies and practices creating a positive impact.
Evaluating Corporate ESG Performance
Basically, ESG investing focuses on companies that have more to offer than just strong financial performance. If two companies were exactly the same, an ESG approach would choose the one with stronger environmental, social, and governance practices.
There are two ways to assess corporate ESG performance:
- Corporate reporting
- Third-party analytics
Companies that are committed to ESG should regularly publish sustainability reports, including measurable ESG goals and their progress toward those initiatives. Look for reports that follow ESG standards set by the Global Reporting Initiative (GRI) and/or the United Nations Principles for Responsible Investment (PRI).
It’s also useful to validate this reporting with third-party reporting. You’ll need different reports for each issue. For example, for environmental issues, a good resource is MSCI ESG Ratings. For employee ratings, take a look at Fortune’s best companies to work for, employee reviews, and Forbes Just 100. For governance, you’ll need to search the SEC website under filing type DEF 14A.
Benefits of ESG Investing
The truth is, investors have long put their money into companies of all types. Why take the time to invest in companies with strong ESG performance?
For one thing, investors and society as a whole are waking up to widespread societal and environmental issues—and they know that major companies have the resources to do something about it. If nothing else, they recognize that environmental, social, and governance issues each pose a serious potential threat to a company’s longevity, and companies with strong ESG practices are the ones forging the future of business.
It’s also worth remembering that strong ESG performance is an indicator of strong corporate leadership. These are the executives who understand that it’s no longer enough to just earn money—you have to do something with it, and they’re willing to lead the charge. If you can find a company with strong ESG performance, you’ll find a company that’s willing to invest in a better way of doing business.
Limitations of ESG Investing
That said, there are key limitations to ESG investment. Two of them, specifically.
First, there is a lack of universal standards. Unfortunately, ESG is not widespread throughout the whole market yet, which means there is no universal set of standards to measure ESG performance. Some ESG funds even hold tobacco stocks. As such, you have to do your homework thoroughly, find standards you can trust, and invest in accordance with your values.
Second, there is the issue of reporting. As of yet, because there is no standard regulatory metric for ESG performance, there is no long-term financial data on ESG companies, and companies that report on ESG metrics are not obligated to do so. As such, you have to read reporting with a critical eye and understand that you may not be seeing all the data. It’s worth working with a professional who knows how to find relevant reporting on this front.
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