Environmental, social and governance (ESG) investing is a strategy you can use to put your money to work with companies that strive to make the world a better place. ESG investing relies on independent ratings that help you assess a company's behavior and policies when it comes to environmental performance, social impact and governance issues.
How Does ESG Investing Work?
The ESG strategy means investing in companies that score highly on environmental and societal responsibility scales as determined by third-party, independent companies and research groups.
"As its core, ESG investing is about influencing positive changes in society by being a better investor," says Hank Smith, Head of Investment Strategy at the Haverford Trust Company.
According to Smith, ESG investing assumes that there are certain environmental, social and corporate governance factors that impact a company's overall performance. By considering ESG factors, investors get a more holistic view of the companies they back, which can help mitigate risk and identify opportunities.
Here's a closer look at the three criteria used to evaluate companies for ESG investing:
Environment. What kind of impact does a company have on environment? This can include a company's carbon footprint, toxic chemicals involved in its manufacturing processes and sustainability efforts that make up its supply chain.
Social. How does the company improve its social impact, both within the company and in the broader community? Social factors include everything from LGBTQ+ equality, racial diversity in both the executive suite and staff overall, and inclusion programs and hiring practices. It even looks at how a company advocates for social good in the wider world, beyond its limited sphere of business.
Governance. How does the company's board and management drive positive change? Governance includes everything from issues surrounding executive pay to diversity in leadership as well as how well that leadership responds to and interacts with shareholders.
For many people, ESG investing goes beyond a three-letter acronym to address how a company serves all its stakeholders: workers, communities, customers, shareholders and the environment.
"Identifying the impact, positive or negative, on these five stakeholders is what should become the measuring stick for quality ESG investing,", says Mike Walters, CEO of USA Financial. "This is important for the obvious impactful reasons relating to each stakeholder, but it also can be used to identify the strength and sustainability of the company itself."
Companies that put in the work to balance the benefits for each of their five stakeholders simply become well-run companies. And well-run companies become good stocks to own.
How Are ESG Scores Calculated?
ESG research firms produce scores for a wide range of companies, providing c clear and handy metric for comparing different investments.
ESG scores represent ratings that research firms assign to individual companies. The rating firms tend to reply on multiple criteria to evaluate each of the individual E, S and G components.
Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv are a few of the most well-regarded ESG research companies. Scores generally follow a 100-point scale: The higher the score, the better a company performs in fulfilling different ESG criteria. Scores may vary among firms, which may employ different metrics and weighting schemes.
While the specific factors assessed vary by company, ESG rating firms commonly review things like annual reports, corporate sustainability measures, resource/employee/financial management, board structure and compensation and even controversial weapons screenings.
Other Strategies for Socially Conscious Investing
While ESG offers one strategy for aligning your investments with your values, it's not the only approach.
Socially Responsible Investing (SRI)
Socially responsible investing (SRI) is a strategy that also helps investors align their choices with their personal values. SRI represents a framework for investing in companies that agree with your social and environmental values.
Whereas ESG investing takes into account how a company's practices and policies impact profitability and future returns, SRI is more tightly focused on whether an investment is more precisely in line with an individual investor's values. ESG factors in corporate performance while SRI solely focuses on the investor's value.
For example, if health and well-being are key values for you, one possible SRI strategy would be to completely avoid investments in companies that make alcoholic beverages or tobacco products. An ESG strategy might be fine with investing in tobacco or alcohol manufacturers so long as the companies social and management policies met high standards, and their environmental record was strong.
Impact Investing
Impact investing is less focused on returns and more focused on intent. With impact investing, investors make investments in market segments dedicated to solving pressing problems around the globe. These sectors could include those making advancements in green and renewable energy, housing equity, healthcare access and affordability and more.
The Global Impact Investing Network (GINN) has four published guidelines for impact investments":
Intentionality. Investments are made with the intention to affect positive social or environmental change.
Investment with return expectations. Of course, investments should generate a return of capital at a minimum.
Range of return expectations and asset classes. Different investment areas should have aligned expectations about returns. Sometimes these returns are below market rate.
Impact measurement. Investments should have an exceptional level of transparency so investors can assess how their dollars help to achieve meaningful change.
Comparing to ESG, impact investing may generate lower returns depending on the sector invested in due to concessions investors make to support earlier-stage ventures in less developed markets. However, for investors with a sincere interest in effecting social equity, impact investing offers a more direct approach to affecting change with highly focused investments.
Conscious Capitalism
Created by Raj Sisodia, a marketing professor, and John Mackey, the co-founder of Whole Foods, conscious capitalism is the belief that companies should act with the utmost ethics while they pursue profits.
The four guiding principles of the movement, as defined by Conscious Capitalism, are:
Higher purpose. Profit for these companies is a reward for a well-built conscious company, not the end-all, be-all. They strive toward a higher purpose an larger impact on the world beyond money and market share.
Stakeholder orientation. A company and its leaders should develop an ecosystem that balances the needs of all stakeholders equally, not overweighting shareholder returns at the expense of other stakeholders.
Conscious leadership. Leaders should work towards developing an inclusive culture and weigh equally the interests of all stakeholders in the business - from employees to shareholders to customers.
Conscious culture. Companies should intentionally create a culture within their businesses that promote their values and purpose.
Conscious capitalism is strikingly similar to ESG - with one notable difference. the principles of conscious capitalism are typically embodied by the leader of a company, which often leads to them running a company with a high ESG score. Thus, when investors practice an ESG-guided investment strategy, they're likely choosing companies that embody conscious capitalism principles.
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