What is ESG Investing?
The ESG in ESG investing stands for environmental, social, and governance. Socially responsible investors look at these three criteria when screening for new investments. The process of ESG investing began in the 1960’s. Investors began excluding stocks, or even entire industries, from their portfolio based on the ethics of their business activities. Since then, investors have increased their ESG consciousness. As a result, ESG investing is thriving.
Environmental looks at a company’s impact on the land. This includes climate change, natural resource conservation, pollution, and waste. Does the company manage its toxic emissions in compliance with government regulations? Does the company plan to cut down on emissions in the future?
Social examines a company’s relationship with all stakeholders: employees, customers, suppliers, and the communities in which it operates. Does the company’s supplier act ethically? Does the company donate a percentage of its profits to charities? Is employee health and safety a major concern?
Governance refers to a company’s management, compensation, internal controls, audits, and shareholders rights. Is the company transparent with its accounting methods? Does the company give strategic political contributions in exchange for favorable treatment?
Everyday there are more ESG conscious investors. Younger investors are more conscientious of being socially responsible in the market. They are looking for companies with practice sustainability and uphold workers’ rights. Major blue-chip companies have recognized this trend and are investing in themselves to become more ESG conscious. Companies that improve their ESG ratings tend to spend more money in the short-term. But, if done correctly, investing in sustainability can improve their long-term performance.
In 2017, Barron’s list of the 100 most sustainable companies returned 29%, compared with 22% for the S&P 500. Seven percent in one year is huge. One goal of ESG investing is to avoid firms that have hard losses from their ESG practices. One recent example is Volkswagen’s emissions scandal. Some other notable scandals include the BP oil spill and Enron’s accounting fraud. These companies lost billions of dollars because of these incidents. Companies are becoming more ESG conscious to avoid that type of loss.
Who Sets ESG Standards?
ESG evaluation can be broad and subjective. But, there are standards in place to evaluate if a company abides by proper environmental, social, and governance practices. The International Finance Corporation provides a great breakdown of environmental and social risks. A few of their ESG categories include Resource Efficiency, Biodiversity, Labor, Land Resettlement, and Community.
MSCI (Morgan Stanley Capital International) has developed its own ESG investing metric. Their sustainable impact metrics are in alignment with the U.N. sustainable development goals. The biggest themes from their metric are basic needs, empowerment, climate change, natural capital, and governance.
ESG investing has become increasingly prominent. More investors are incorporating ESG data into their analysis. You can learn more about ESG integration by checking out the CFA Institutes ESG integration report that covers equities and fixed income. ESG investing is an international trend. Paul Smith of the CFA institute wrote, “Consensus is emerging in many countries that it is asset managers’ fiduciary duty to incorporate ESG factors into their financial analysis, especially when material to a company’s long-term prospects.”
Does ESG Hurt Performance?
Some investors worry that they are sacrificing returns when investing in companies with ESG mandates. This could not be further from the truth. In a 2015 study, Oxford University and Arabesque Asset Management studied 200 ESG focused companies and reported that 88% benefited from their ESG performance: “robust sustainability practices demonstrate better operational performance, which ultimately translates into cash flows.” Prudent sustainability practices do not hurt performance. In fact, they increase profits and have a positive impact on the company.
Top ESG Companies
Many companies are improving their ESG ratings, but a few stand out. Socially responsible investors put a good chunk of change into the following companies…
- Cisco Systems – is aggressively increasing its use of renewable energy. Last fiscal year, it accounted for 80% of Cisco’s electricity use.
- Best Buy – plans to reduce carbon emissions by 60% by 2020. Best Buy also collected 178 million pounds of electronics and appliances for recycling last year.
- Texas Instruments – is committed to engineering a better tomorrow, and has a plan that includes recycling, reducing emissions and reducing environmental footprint.
- Microsoft – plans to lower carbon emissions by 75%. Microsoft has also committed $50 million to solve global environmental challenges.
- Clorox – goes beyond environmental compliance requirements. By 2020, Clorox wants more than 90% of its products to be in recyclable primary packaging.
Socially responsible investing is gaining traction. These companies are pioneering a new standard for ESG investing. Some of them also reward their shareholders with big dividends. To learn more about dividends, check out our guide to dividend investing.