Socially Responsible Investing has taken the internet by storm and encouraged many investors to hop on the sustainable bandwagon. Besides SRI, ESG investments have also gained recognition as they consider an organisation’s environment, social and governance practices and traditional financial measures. Before proceeding further with the topic, let’s first get to know what does ESG investing mean?
What is ESG Investing?
Environmental, Social, and Governance Investing is a strategy to put your money to work with organisations or companies that strive to protect the environment and preserve and maintain the local areas. ESG, representing Environmental, Social, and Governance, investing relies on independent ratings that identify a company’s environmental performance in terms of its social impact and governance issues.
Environmental, Social, and Governance Investing is witnessed as a sustainable way of investment. ESG based investing considers the well-being of the environment, humans and the economy.
This guide will brief you on everything you need to know about ESG investing. But before we proceed to know how ESG investing works, let’s dive in straight to know the:
Key Takeaways
- ESG investing is sustainable, unlike other traditional/conventional investing methods.
- This investment style primarily focuses on bringing positive changes in the environment and protecting our society from unwanted, toxic substances.
- The 3 criteria used by ESG investing to evaluate an organisation’s metrics include Environment factors (conservation of the natural world), Social impact (consideration of people and relationships), and Governance issues (standards for running a company).
- Some of the leaders in ESG investing include Microsoft, Accenture, Linde and J.B Hunt, with an ESG score ranging between 74.14 to 76.30.
How Does ESG Investing Work?
ESG investing covers a wide array of topics applicable to multiple sectors and companies in one way or the other. ESG based investing is solely based on the societal and environmental responsibility scales determined by independent organisations, a third party, and research groups. The modern investment approach entails a comprehensive scope of issues and focuses on avoiding sin stocks, which was considered central to investing ethically.
According to Hank Smith, the Head of Investment Strategy at The Haverford Trust Company, “ESG investing is more about bringing positive societal changes by being a better investor.”
The ESG statement of investment principles allows investors to get an extensive holistic view of the companies they support, further empowering them to identify new lucrative opportunities and minimise risks. This has considerably driven up the demand for ESG investing.
What Criteria are Used by ESG Investing to Evaluate Companies?
ESG investing consider 3 crucial aspects to assess and evaluate companies for ESG investing:
1. Environment
This measures the companies’ environmental impact. It includes the toxic chemicals released by zinc and lead compound units or the increased carbon footprints from massive CHG emissions. It considers all hazardous materials produced by industries as part of their manufacturing processes and sustainability efforts that make up a company’s supply chain.
2. Social
This determines the scope for social improvement within a company or the broader community. The social criteria cover a wide range of potential issues from the socially responsible investors’ point of view. These criteria underline a company’s relationship with its employees and its focus on employee welfare.
3. Governance
This section views the role of the board of directors and how the top management drives a positive change within the company and its stakeholders. The governance issues also examine whether the organisation is giving back to the community and if so, how.
Why is ESG Investing Important?
The demand for ESG investing is witnessing a significant boom because of many reasons. Let’s find out why ESG based investing has become indispensable today:
1. Minimal Risk
During the turbulent market scenario, such as in 2008, 2015, 2018 and 2020, conventional funds had a higher potential for loss as compared to ESG investing funds.
2. Yield High Returns
In its initial phase, many investors used to think that these investment opportunities would turn out to be feeble and lead to weaker returns. However, the data stated that ESG investments have an immense potential to outperform conventional investments.
3. Linked to Top-Line Growth
ESG investing provides an upper hand for businesses to expand in existing markets and enter new ones. Efficient ESG investing trends help companies attract B2C and B2B clients by providing them with sustainable products.
4. Make Long-Term Investing Decisions
Investing in ESG funds means you are investing in brands that are making continuous efforts to make the world a better place and protect the planet. ESG practices empower investors to consider sustainability challenges like climate change, global warming, inequality, increasing population, and other environmental risks.
One of the potent strategies to invest in ESG funds is to identify the business with the right ESG metrics and make healthy long-term investment decisions.
5. Uplift Employee Productivity
ESG investing prioritises employee welfare and helps retain them, boost their morale by giving them a sense of purpose and increase their productivity.
What are the types of ESG Investing?
Typically, investors can create their ESG portfolio to include two kinds of ESG investments:
I) ESG Stocks- Invest in a particular company offering a compelling ESG impact report.
II) ESG Mutual Funds- If you are looking to diversify your holdings instantly, fill your portfolio with the ESG mutual funds option. After comparing different mutual funds, analyse how their ESG ratings stack up.
Different Strategies for ESG Investing
Investors follow these four critical approaches to ESG investing:
1. ESG Integration
This strategy requires the investors to integrate ESG and traditional factors to assess the risk profile of their investment.
2. Inclusionary Investing
This approach is based on seeking out high-ranked companies based on the sustainability criteria.
3. Exclusionary Investing
Investors are looking to screen out controversial companies that do not meet the sustainability criteria, such as tobacco or fossil fuel, as also companies whose revenue is generated through immoral activities like gambling.
4. Impact Investing
This approach focuses primarily on renewable energy companies that intend to protect the environment from harmful emissions and hazardous effluents that can prove detrimental to human health.
How are ESG Scores Calculated?
The growing need to measure an enterprise’s ESG performance has put forth the idea of scoring systems to gauge ESG performance. While the scoring systems are subjective, a reliable scoring system presents an objective and accurate. The scoring system is based on the data disclosed by enterprises. An ESG score mathematically measures an organization’s performance on an extensive range of ESG verticals.
Pros and Cons of ESG Investing
| Pros | Cons |
| Provides a sustainable and stable rate of return compared to traditional funds. | ESG investments may be more expensive compared to conventional funds. |
| Negative screening eliminates all the sin stocks such as alcohol, gambling, tobacco, pornography, and weapon manufacturing companies. | Becomes difficult for a fund manager to accommodate every investor’s preferences. |
| Endeavour to practise responsible investing in line with principles set out by CFA’s ESG Disclosure Standards. | Greenwashing or Green values can be deceptively used to convince investors that a company is environmentally friendly. |
Did You Know?
The reports added that ESG integration emerged as the largest sustainable investment strategy, with a market share of 43% in 2020. Moreover, the Environment, Social, and Governance integration was followed by shareholder action at 17.9% and exclusionary screening at 25.7%.
Words to Remember
SRI – Socially Responsible Investment
SRI is a strategy allowing investors to align their preferences with their personal values. It is based on the framework agreeing with your social and environmental values.
Conclusion
Want to invest in a particular ESG fund? It is advisable to do extensive research on the company you want to invest in. Look through its prospectus and make an informed decision.
As an investor, you may want to research all aspects of ESG investing. You can then harness your understanding of ESG strategies to invest wisely. You may seek out top-rated ESG performer companies and do a risk/reward analysis and examine the environmental impact of these organisations.
Once you have a firm understanding of ESG funds, it will become easier to invest in them and reap sustainable returns. So, opt for them today, and let us know which ESG fund you put your money in.
Also Read: Return on Investment
FAQs
ESG Investing is a strategy to put your money to work with organisations or companies that strive to protect the environment and preserve and maintain the local areas
The full form of ESG is Environmental, Social, Governance
Environmental
– Conservation of the natural world
– Climate change and carbon emissions
– Air and water pollution
Social
– Consideration of people & relationships
– Customer satisfaction
– Data protection and privacy
Governance
-Standards for running a company
– Board composition
– Audit committee structure
The essential pillars of ESG are –
– The environmental pillar
– The social pillar
– The governance pillar
ESG was launched by the United Nations.
Most ESG investors classify ESG investing to be very profitable.
Companies use the ESG (Environment, Social, and Governance) criteria to rank in the ESG list. The organisations are scored as per their performance in each category.
Different methodologies are followed to calculate ESG scores. MSCI ESG Research is the largest body responsible for providing ESG ratings. They rely on multiple databases starting from both company disclosures and government and NGO databases. Moreover, the industry-specific questionnaire is also used to gather self-reported data from participant companies.
Some of the best ESG stocks are:
– Nestle India
– P&G Hygiene & Healthcare
– Colgate-Palmolive India
– Page Industries
ESG analysis provides extensive insights into the factors impacting the financial metrics of an organisation. This approach helps investors to be better informed about investment decisions.
In addition, with the increasing environmental issues, investors are paying more heed to ESG investing strategies. This has almost doubled the ESG funds between 2020 and 2022.
More than 66% of the investors have incorporated ESG investments in their portfolios. At the same time, 44% of investors are incorporating these investments in a quarter of their portfolio.
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