What is ESG?
ESG stands for Environmental Social and Governance. These are the three key features to use when measuring the sustainability and ethical impact of an investment. Increasingly socially responsible investors use ESG criteria to screen potential investments.
The ESG investment approach is based on the philosophy that environmental, social and governance components can have an impact on company success and market returns.
Investors may consider a number of different ESG features, metrics and data when looking to adopt such a strategy. These factors typically include industry-specific issues such as carbon footprint, climate change, labour management, corporate governance, privacy and political views, among many others.
ESG is nothing new
Socially responsible investing has been around hundreds of years. In the 18th Century, Quakers and Methodists both laid out clear guidelines to followers over the types of companies in which they should invest. Then in the 1960s it became more formalised with investors excluding stocks or indeed, entire industries from their portfolios based on business activity like tobacco production or political support such as opposition to the civil rights movement. What’s clear is ESG investing is on an upward trend. In 2018, investors and asset managers evaluated ESG in approximately $12 trillion worth of assets, an increase of nearly 40 percent over two years.
A closer look at the three pillars
Within each pillar, management firms and investors can evaluate a variety of criteria or specific issues to determine how an individual company performs.
The environmental pillar
The key question to ask here is how does a company’s behaviour affect or impact the environment?
Admittedly, this is a fairly broad-based category. Climate change, pollution and waste are prominent considerations, however there are a number of other issues that could be a risk to a company’s long-term financial health and survival. These include:
- Its use of or dependence on fossil fuels
- Its use or management of water and other resources
- Pollution levels
- Climate change
- Hazardous materials and their disposal
- Carbon footprint and whether it uses renewable energy
Investors can also consider environmental opportunity such as:
- Switching to renewable sources of energy or fuel
- Utilising processes that conserve resources and minimise pollution
- Adopting a carbon neutral stance or reducing carbon footprint
- Planet restoration for example planting trees
- Adopting clean energy initiatives
Environmental considerations take on particular significance when looking at companies in the chemical, energy and utility sectors.
The social pillar
In this pillar we consider the effect of a company’s behaviour regarding social issues. These could include:
- Employment equality and gender diversity
- Product safety concerns and liability
- Employee health and safety
- Training and development
- Animal testing
- Stance on various physical and mental health-related issues, such as topics such as drug abuse, gambling and reproductive choice
- Supply chain transparency
- Human rights
- Privacy issues
The governance pillar refers to how a company operates internally, its corporate behaviour.
Other government issues that might be considered when evaluating a company include:
- Compensation of employees and board executives
- Board and company diversity
- Tax strategy and accounting standards
- Bribery and corruption
- Ethics and values
- Transparency and anti-corruption
- Shareholder rights
There are no official rules or clear guidelines about how an investment house should include ESG values in its investment selection criteria, indeed many continue to ignore ESG entirely. It’s up to the individual asset owners to choose which methodology best fits their values.