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ESG (Environmental, Social, and Governance) – The Ultimate Guide

ESG Definition

ESG stands for Environmental, Social, and Governance, which are three criteria ESG refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. ESG investing grew out of investment philosophies such as Socially Responsible Investing (SRI), but there are key differences. Earlier models typically use value judgments and negative screening to decide which companies to invest in. ESG investing and analysis, on the other hand, looks at finding value in companies—not simply at supporting a set of values.

Environmental Investing

Environmental refers to investing in the principles or guidance to improve environmental Sustainability. Environmental investing concerns topics below:

  • Climate change and carbon emissions prevention investing
  • Air and water pollution reduction investing
  • Biodiversity improvement investing
  • Deforestation technology and project investing
  • Energy efficiency technology and promotion investing
  • Waste management and waste reduction investing
  • Water scarcity reduction investing
  • resource depletion
  • greenhouse gas emission
  • climate change

Environmental investing factors look at a company from the perspective of pollution, resource waste or conservation, and animal treatment practices. Logically, a company that is profitable, but risks a significant lawsuit due to environmental damage may face costs that would impact shareholder value or tarnish the brand itself.

Environmental Sustainability

Social Investing

Social refers to investing in the principles or guidance to improve Social sustainability. Social investing concerns topics below:

  • Human rights
  • working conditions, including child labor and slavery
  • local communities; seeks explicitly to fund projects or institutions that will serve poor and underserved communities globally
  • health and safety
  • employee relations & diversity
  • Customer satisfaction
  • Data protection and privacy
  • Gender and diversity
  • Employee engagement
  • Community relations
  • Animal welfare

Corporate Governance

Governance factors include ensuring a company is keeping accurate and transparent standards for employees and shareholders. This also includes controlling possible conflicts of interest that could impact shareholder value. If a company is controlled by a small group of investors, others would want to be assured they have a common alignment of interests for corporate growth and profitability. Governance criteria, which examines how a corporation polices itself – how the corporation is governed, and focuses on:

  • tax strategy
  • executive remuneration
  • donations and political lobbying
  • corruption and bribery
  • board diversity and structure

Human-rights

ESG investing arguments

Companies that take ESG aspects seriously are generally better managed and do business more sustainably and more with the future in mind. Companies with high ESG ratings are more crisis-resistant and achieve better performance marks on average than their peers.

  • ESG investments can curb risk and exert positive impacts at the same time.
  • ESG investments tend to exhibit better risk/return attributes than equivalent traditional investments.
  • ESG criteria are a key sign of quality.

There are also other advantages:

Feel-good factor: Perhaps the most obvious advantage of SRI is the positive feelings you will have when an ethical holding performs well. If a company shares your values and delivers socially responsible projects, you could benefit both financially and emotionally from your investment.

Future profit potential: People are becoming more ethically driven in their purchases, which means socially responsible firms are likely to see improved profits as consumer behaviour shifts. In fact, Nielsen statistics found that nearly three-quarters of millennials would pay a surcharge for sustainable goods and services.

Catalyst for change: As investors begin backing more socially responsible companies and projects, other businesses will strive to improve their ethical practices to attract funding. Over time, organizations will move towards more sustainability, which can only be good for the environment and other important social causes.

Governance data, unlike environmental or social data, has been compiled for a longer period of time and the criteria for what comprises good governance and its classification has been more widely discussed and accepted. Harvard researchers Gompers, Ishii, and Metrick (2003) constructed a Governance Index (G-Index) consisting of 24 governance provisions that weaken shareholder rights and ranked companies based on their scores. ESG standards are gradually becoming a significant part of the alternative investment world. ESG issues are not only important when measuring the sustainability of the non-financial impacts of investments – they may also have a material impact on the return profile and long-term risk of investment portfolios. A company that practices good governance can be characterized by a diverse board that’s inclusive of women and minorities, transparency when it comes to accounting and financial reporting and executive compensation that’s tied to revenues rather than some arbitrary metric.

ESG Investing Impact Measurement

Impact is the outputs, short-term outcomes, long-term outcomes, and other effects we, and the borrowers we work with, have on our various stakeholder communities. Impact measurement and valuation strive to assess whether companies have business programs for social needs, such as strategic social investments, and if they are measuring and valuing their broader societal impacts with metrics. Companies need to analyze the impacts of externalities that are not currently reflected in financial accounting, but which, over time, may have the potential of becoming priced in. As ESG-minded business practices gain more traction, investment firms are increasingly tracking their performance. Financial services companies such as JPMorgan Chase, Wells Fargo, and Goldman Sachs have published annual reports that extensively review their ESG approaches and the bottom-line results.

ESG Investing challenges

ESG is not perfect, it is an ideal and principles. It has its own challenges.

Time and research: ESG investing isn’t a passive strategy, and you often have to spend time researching potential investments thoroughly to ensure they align with your values. This can become quite complex if every investment in your portfolio must meet certain benchmarks.

Not often an optimal strategy: It’s unlikely that an ESG Investing strategy will provide optimal returns, so you could be sacrificing financial gains by embarking on an ethical approach. Some people prefer to pursue conventional investment strategies and instead donate a certain proportion of their profits to charitable causes.

Higher fees for ESG Investing: The fees attached to ESG Investing can be higher due to the additional research required to find the right investments for your particular belief systems. This can eat into your portfolio’s profits, especially if your investments aren’t performing as well as traditional strategies.

ESG investing Synomyns

EST investing is also referred to as ethical investing. Ethical investing is any investment strategy in which you apply your values to your portfolios and investment strategies. 

Social Investing is an investing discipline to invest in companies, projects that improve social sustainability, examples are:

  • Human rights
  • working conditions, including child labor and slavery
  • local communities; seeks explicitly to fund projects or institutions that will serve poor and underserved communities globally
  • health and safety
  • employee relations & diversity
  • Customer satisfaction
  • Data protection and privacy
  • Gender and diversity
  • Employee engagement
  • Community relations
  • Animal welfare

Learn more at best of ESG articles.

Environmental Investing is an investing discipline to invest in companies, projects that improve environmental sustainability, examples are:

  • Climate change and carbon emissions prevention investing
  • Air and water pollution reduction investing
  • Biodiversity improvement investing
  • Deforestation technology and project investing
  • Energy efficiency technology and promotion investing
  • Waste management and waste reduction investing
  • Water scarcity reduction investing
  • resource depletion
  • greenhouse gas emission
  • climate change

Learn more at best of ESG articles.

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About the author

Jess Man

Jessica is the Editor-in-Chief and Senior Diversity Advisor at Diversity Social. Jessica has over 10 years of working with and advising employers to be more diverse and create an inclusive working environment.
Jessica's experience spans private and non-profit sectors in multiple industries.
Jessica's expertise experience is beyond Diversity & Inclusion, she is also a certified professional IT recruiter in Data & Analytics, Database administration, Artificial Intelligence area.