What is ESG investing?

What is ESG investing? image

ESG stands for Environmental, Social, and Governance considerations when investing.

It’s a strategy that considers not only financial returns but also the environmental, social, and governance factors of a company or investment. 

  1. Environmental Factors: This includes how a company interacts with the environment. Investors look at things like a company’s carbon footprint, energy efficiency, waste management practices, and use of renewable resources. 

  1. Social Factors: This focuses on how a company manages relationships with its employees, suppliers, customers, and communities. Social factors can include labour practices, human rights, diversity and inclusion, community development, and consumer protection. 

  1. Governance Factors: This pertains to the quality of a company’s management and oversight. It involves issues like board diversity, executive compensation, shareholder rights, transparency, and ethical business practices. 

ESG investing aims to support companies that operate sustainably, ethically, and responsibly, while avoiding those with poor ESG practices that may pose risks to investors, society, or the environment. It’s often seen as a way to align investment decisions with personal values or societal goals, alongside financial considerations. 

To help investors and professional advisers understand how different companies meet ESG requirements and encourage investment in those who are more successful at it, there is a growing amount of information available designed to score companies against different ESG criteria. 

How Are Companies Scored for ESG? 

ESG scores are typically obtained through various sources, including specialized ESG research firms, data providers, and financial institutions. These entities use a combination of methodologies and data sources to evaluate companies’ environmental, social, and governance performance. 

There has been a lack of consistency and, possibly, an over reliance on the data provided by companies in the early stages of ESG investing, and this has led to some criticism of the reliability and independence of the results published. There is no doubt, however, that the profile of ESG investing has risen dramatically in recent years, and this is a trend which is unlikely to stop. Pressure for this has been mounting from multiple directions: 

  • The European Union’s Sustainable Finance Disclosure Regulation (SFDR) mandated market disclosure on sustainability risks. 

  • International global climate agreements have put pressure on governments and businesses to reduce carbon emissions and transition to a low-carbon economy. 

  • Activist shareholders and advocacy groups are increasingly engaging with companies on ESG issues through shareholder resolutions, public campaigns, and dialogue with corporate management. 

  • Financial regulators and central banks are increasingly recognising the systemic risks posed by climate change and other sustainability challenges. They’re urging financial institutions to assess and mitigate these risks to ensure the stability of the financial system. This has led to greater emphasis on incorporating ESG factors into risk management frameworks and stress testing processes. 

  • Scandals and corporate governance failures have prompted regulatory reforms aimed at improving transparency, accountability, and ethical behavior in corporate governance. 

  • Most importantly investor demand is increasing. Institutional investors, asset managers, and pension funds are facing growing demand from clients and beneficiaries for sustainable investment options. As awareness of ESG issues increases among investors, there’s pressure on financial institutions to offer ESG-focused products and integrate ESG considerations into their investment processes. 

The market is not yet mature enough to offer a perfect solution for everyone. It is still in a state of transition, and will develop enormously over the next few years, as both data and consumer understanding improves. 

As ethical financial advisers we are more than happy to discuss how ESG investing might be of interest to you. 

It is important to take professional advice before making any decision relating to your personal finances. Information within this article does not provide individual tailored investment advice and is for guidance only. We cannot assume legal liability for any errors or omissions it might contain. Ethical Futures llp is authorised and regulated by the Financial Conduct Authority.

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