The shifting landscape of the business world means new trends constantly come and go. However, when it comes to ESG, it seems that it’s here to stay. For novice investors who are exploring the different ways to improve their financial stability, it’s worth looking into ESG as a sustainable form of investing money.
The following article provides a detailed overview of ESG investment for beginners. Read on to learn more.
What Is ESG Investing?
ESG investment, short for environmental, social, and governance investment, is a type of sustainable investment used to build financial wealth. Like all forms of investment methods, ESG too considers the monetary returns of the investment. However, what’s different about ESG is that it also takes into account the overall impact of putting one’s money for the given cause.
In other words, you can think of ESG investing as funding a company that is not involved in the production of weapons, tobacco, and gambling. ESG investors typically avoid companies in the traditional energy sectors that are fossil fuels dependent. However, this is only one way to look at ESG investments. The real concept of ESG is broader than that.
People interested in ESG investments also factor in the company’s energy efficiency, waste management policies, carbon footprint, internal environment, and more issues, such as compliance with workplace health and safety rules.
Put simply, ESG is an umbrella term for selective investments that not only seek positive returns for the investor but also considers the long-term effects of the investment on the business’s performance, the world environment, society, and the global economy as a whole.
The ESG Criteria
To fully understand how this form of investment works, it’s essential to know each of the three components that make up ESG.
- Environmental – The environmental component basically includes all big and small steps that a company takes to mitigate the impact of its operations on its surroundings. This first and foremost includes the sustainability of the goods or services that it provides. For instance, how efficiently the company uses the available resources, how it handles recycling, controls the emission of greenhouse gases, and so on.
- Social – Social factors include elements that are both internal and external to the company. For example, is the company taking any steps to improve the local or global community? Is it an equal opportunity employer? Does it embrace diversity or not? Are its business practices aimed at protecting human rights?
- Governance – This component highlights the managerial side of the business as it revolves around the company’s board of directors and other leadership teams. Some of the main things that come under governance are how diverse the company’s executive team is, how well the members are paid, and how responsive they are to the shareholders’ needs.
Why Is ESG Investment Trending?
The ESG analysis that precedes the decision to invest in the said company is of prime importance for investors. It provides valuable insights into the various factors that can have a major impact on the company’s financial metrics. ESG can, therefore, help investors make informed decisions.
Smart investors excessively rely on the non-financial components of ESG to guide them in identifying material risks and amplifying growth opportunities.
It’s worth mentioning that ESG investing is not particularly a new form of investment. It was first introduced in the 1960s as a type of socially responsible investment method. Investors would typically exclude stocks or even entire industries from their portfolio if the company was known to support activities such as tobacco production.
In the present day world, ESG has gained massive traction among modern investors, predominantly the millennials, as people are becoming increasingly more conscious of the impact of their investments. A survey conducted by the Morgan Stanley Institute for Sustainable Investing in 2019 found that 95% of millennials prefer ESG as a more ethical way of building their portfolio . But that’s not all.
Evidence suggests that ESG investments usually carry less risk than traditional investments. The same study by Morgan Stanley reports that irrespective of the asset class, ESG funds show lower downside risk as compared to their traditional alternatives. During turbulent market conditions such as those experienced in 2008 and 2015, non-ESG funds had a significantly larger downside deviation than the sustainable ones.
Moreover, among the main reasons behind the rising popularity of ESG investments is that it allows people to support businesses whose vision and mission align with their own values. With ESG investments, you can filter out companies you think are working towards a greater good and thus, fund them with investment capital.
ESG: Creating Value Globally
The drive toward sustainability is dual powered. Where investors are looking for more environmentally-friendly businesses, companies are also becoming more conscious of the impact of their activities.
Research shows that high-end private investors are more willing to fund companies that have a high sustainability rating. On average, enterprises with good sustainability ratings receive around 15% more capital in investments than competitors firms on a relatively lower rank . A market study conducted last year found that funds that took ESG factors into consideration outperformed their equivalent non-ESG funds even during the COVID-19 crisis .
Getting Started with ESG Investing
Starting with ESG investment for beginners is fairly easy. Generally, there are two main things that you need to sort out before investing.
Define Your ESG Policies
The boundaries of ESG are quite well-defined. However, different people can have different views about what really makes a company ‘ethical’ with respect to its environmental, social, and governance policies. Therefore, take some time to think about what values are most important to you. This will help you in choosing the right company to invest in.
Once you know your ESG criteria well, decide who manages your investments. If you have a considerably strong understanding of how ESG investing works, you can do it on your own. Otherwise, it may be better to look into automated investment management solutions. There are various digital advisor services that can create and manage your investment portfolio without you having to fumble around with the numbers.
Organizations such as Patagonia and Desserto have been following ESG practices and are conscious about the impact of their business on the environment. They follow sustainable practices that appeal to a large base of customers.