To make an investment, the financial statements numbers are critical. Today many investors are considering non-financial insights about an organization when making an investment decision. This involves components such as identifying and tackling climate change, diversity, or equal pay. This type of investment strategy is referred to as environmental, social, and governance investing or ESG investing. Socially responsible investing strategies are slowly becoming increasingly popular among investors.
But what exactly is ESG investing, and how can organizations incorporate it into their investment portfolio?
An ethical investing strategy, ESG investing helps investors, businesses, and people to align their investment choices with their values. ESG investors aim to purchase the shares of organizations that demonstrate their willingness to improve their performance across the three areas of ESG.
What Is ESG?
An acronym for a set of environmental, social, and governance standards, ESG is a socially conscious framework critical for investors to select investments. Some examples of ESG category include:
Environmental
Social
Governance
These criteria help in identifying how well public companies are employing measures to safeguard the environment and the societies they function in, along with how they ensure management and corporate governance. ESG can mean different things to different individuals. And there is no agreed-upon definition for organizations as well as investors.
Read more: ESG Score - Definition, Process, Implications & Purpose
What is ESG Investing?
ESG investing can be defined as investing that encompasses sustainability principles along with ESG criteria in the investment decision-making process. At the very core, ESG investing is about influencing a positive change in society by fostering a sustainable investing environment for investors. ESG stands for environmental, social, and governance, and each category broadly implies:
-
The environmental factors that are used to measure how business practices impact the world’s ecosystems.
-
The social factors involve the well-being and safety of employees and how businesses interact with the communities they function in.
-
Governance factors enable organizations to evaluate the ethics and longevity of their management.
ESG investing incorporates environmental, social, and corporate governance factors that impact an organization's overall performance. By evaluating ESG factors, investors gain a holistic view of the firms they back, thereby mitigating the risk and identifying new opportunities for growth.
The ESG Investing Boom
In recent years, there has been a significant expansion of ESG investing across the globe as organizations and individuals are increasingly recognizing the interdependencies between social, environmental, and economic issues. The pandemic further encouraged this trend notably. Uncertainty and market disruptions led to many investors turning to ESG funds for increased resiliency. Today, $30.7 trillion sits in sustainable investment funds globally, and it is predicted to rise to $50 trillion in the next two decades.
More and more investors are scrutinizing funding organizations and products that support and promote sustainability while complying with emerging regulations like climate change. This growing demand has been met with increased action on ESG issues and progressively higher returns on ESG investments due to resilience against conventional market disruptions. Organizational portfolios incorporating ESG, and sustainability are known to perform better in the long term.
This boom in ESG investing can be attributed to a different range of components. And with the supply chains becoming more complex, there is a broader awareness of social and human rights issues and risks for the business world. There has also been a growing concern for environmental issues, including climate change, that influence investor decisions. The elevated engagement of groups - particularly young people and women - is further contributing contributed to the ESG investing boom. To reflect the evolving societal values, it is essential for organizations to adopt forward-looking ESG practices to remain competitors in their industry.
Industries are receiving increasing pressure from stakeholders, investors, and concerned citizens to incorporate sustainable investments into their operational framework. And with legal obligations expected to tighten for industries progressively, they are likely to face more pressure from their shareholders to reduce their contributions to climate change. Such events will spark further transformations within these industries.
Read more: ESG Strategy for Growth: Embedding ESG in the Business Model
How Does ESG Investing Works?
Let's have a closer look at the critical criteria used to evaluate ESG investing in an organization:
-
Environment: The kind of impact a company has on the environment is calculated in the aspect of ESG. This can involve an organization's carbon footprint, its mitigation of toxic chemicals in its manufacturing and processes, along with its pursuit of sustainability through the supply chain.
-
Social: This requires the organization to improve its social impact - within the company as well as in the broader community. Social factors also include LGBTQ+ equality and racial diversity in the executive suite and staff, along with inclusion programs and hiring practices.
-
Governance: This highlights the organization's board and management drive to positive change. Governance encloses everything from issues covering executive pay to diversity in leadership.
Why Choose ESG Investing?
ESG investing in an organization helps ensure that their investment choices align properly with the organizational values and priorities. And this is emerging as one of the critical reasons to pursue ESG investing.
Investors are voicing their concerns about environmental and social problems like climate change leading to severe climate crises, gender inequality, data security, and privacy. They are also ensuring that they do not invest in firms that contribute to such problems. But aside from supporting the fight to overcome climate change crisis and social injustice, ESG investing strategy can further offer organizations with higher returns.
ESG indexes and funds have recently outperformed broad indexes, and they have done this partly because of the greater percentage of tech companies. Research has highlighted that ESG investments actually help organizations in mitigating risks.
It is equally important for investors to have a mix of sectors represented in their investments in order to lower the risk of poor performance in one tank of their investment. This will further help in balancing out any risks the invested funds can introduce sectors.
ESG Strategies to Consider for Socially Conscious Investing
ESG offers different strategies to investors to align their investments with their values. The approaches include:
Socially Responsible Investing
Socially responsible investing, or SRI, helps investors in aligning their investment choices with their personal values. SRI also presents a framework for investing in organizations that agree with their social and environmental values.
ESG investing takes into consideration the different practices and policies of an organization that impact profitability and future returns. And with socially responsible investing, investors can focus their investment and align it with their values. While ESG focuses on corporate performance, SRI evaluates an investor’s personal outlook.
Read more: The Future of Corporate Sustainability: 2023 Predictions
Impact Investing
Impact investing is focused on returns and intent. With impact investing, investors can make investments across different market segments dedicated to solving pressing problems. These sectors include industries making advancements in green and renewable energy, along with housing equity, healthcare access, and affordability. Research has highlighted different guidelines for impact investments. They are as follows:
-
Intentionality: Investments made with the intention of having a positive social or environmental impact.
-
Investment with return expectations: Investments that help to generate a return of capital at a minimum.
-
Range of return expectations as well as an asset class: Impact investors have various financial return expectations. While some settle for below-market-rate returns to achieve their strategic ESG objectives, others want their investments to outperform the broad market.
-
Impact measurement: Investments that offer an exceptional level of transparency for investors to achieve meaningful change.
Compared to ESG, impact investing helps in generating lower returns. Lower returns can also be considered as a part of a trade-off that impacts investors make to support earlier-stage ventures. For investors with a sincere interest in social equity, impact investing presents a direct approach to affecting change with a high focus on investment.
Conscious Capitalism
Conscious capitalism implies that organizations should act with the utmost ethics while pursuing profits. The four guiding principles of the conscious capitalism movement include:
-
Higher purpose: Profit for such companies is considered a reward for a well-built conscious company. They further strive to achieve a higher purpose and create a major impact on the world beyond market share.
-
Stakeholder orientation: Organizations and industry leaders should develop an orientation framework that helps in balancing the needs of every stakeholder equally, without overweighting shareholder returns at the cost of other stakeholders.
-
Conscious leadership: Leaders should integrate measures towards developing an all-inclusive culture by weighing in the interests of all stakeholders in the business, ranging from employees to shareholders and customers.
-
Conscious culture: Organizations should work towards creating a conscious culture within their business practices that helps in promoting their values and purpose.
Today, conscious capitalism is being perceived as a concept like ESG but with one notable difference - the principle of conscious capitalism is embodied by the leader of an organization which leads to them driving the firm with a high ESG score. Thus, when investors practice an ESG investment strategy, they will choose organizations that represent conscious capitalism principles.
Read more: Environmental Sustainability in 2023 and Beyond – The Strategic Imperative
Key Takeaways
-
ESG investing strategies take an organization's environmental, social, and governance factors into consideration and are estimated to reach $50 trillion in the next two decades.
-
Environmental, social, and governance or ESG factors are used to evaluate an organization's investment sustainability.
-
A form of sustainable investing, ESG investing incorporates environmental, social, and governance components to evaluate an investment’s financial returns and impact.
-
ESG strategies, including impact investing, are gaining momentum and growing as shareholders are demanding actions.
-
One of the most favored ways to evaluate the metrics is through ESG integration. This strategy helps in evaluating the stock through an ESG lens along with other traditional metrics such as capital allocation and cash flow.
-
There are different ways to take an ESG-style investing approach, such as ETFs that help in tracking indices and specialty funds that do not include stocks related to polarizing areas of the market.
-
ESG strategies have proven to be market-beating in the last few years.
Conclusion
Today, it has become critical for organizations to recognize and embrace the shifting ESG investing landscape. The term investor is no longer solely used to refer to a select group of people. Rather, it is increasingly used as a tool to attract a diverse spectrum of people across the globe. The range of factors considered by investors when making decisions has become much broader, reflecting the gradual diffusion of progressive and holistic ESG values. The issues prioritized by investors and organizations are determined by the environmental, social, and economic circumstances of the time and are deemed important for a company. Some of the prominent issues influencing ESG investment include:
-
Efforts are being taken by organizations to mitigate climate change and environmental disasters like biodiversity loss. To achieve net-zero emissions, organizations are incorporating new policies within their operations.
-
Workplace diversity and equal opportunities are enabling organizations to identify diversity in management.
-
An organization’s performance against ESG enables stakeholders to make key decisions. Many tools are available to measure and report ESG performance.
-
ESG values enable companies to measure and report their performance in a range of areas, such as governance, climate-related risks, resource management, and engagement strategy.
Climate change is demonstrating the fragility of businesses and their usual approaches. It has further brought to light the importance of organizational resistance to sustainable investment. Shareholders and stakeholders are now compelling businesses to transition towards more environmentally, socially, and economically sustainable activity to support future generations. Organizations need to build adaptive capacities by considering a wider range of metrics in their operations and long-term strategies. By identifying ESG benchmarks that are material to them as well as setting robust targets, organizations can set themselves up for sustainable growth.
