What does ESG Investing mean for your business?

Just what is ESG investing and what does it mean for your business?

First we need to start with the basics. What does ESG stand for?

‘ESG’, or Environmental, Social and Governance, refers to a set of standards used to measure a typical organisation’s environmental and social impact. It’s normally used in the context of investing, although it also applies to customers, suppliers, employees and the general public.

The term ‘ESG’ became popular in the 21st century and often comes up in the same conversation as sustainability and corporate social responsibility (CSR). But while sustainability and CSR function more as philosophies or end-goals, ESG is more tangible; it combines the data and metrics needed to inform decision-making for companies and investors alike.

So is ESG a new concept for the corporate world?

Not as new as it may seem to some. If the history of ESG (environment, social and governance) can show us one thing, it’s that the concept is a lot older than we might think.

It’s grown exponentially in the last few decades, and love it or hate it, it’s very important and now impacts almost every organisation.

In fact, experts recently claimed [cited by the Corporate Governance Institute] that financial firms worldwide would have ‘no choice’ but to embrace ESG in today’s market.

So when did these ESG standards start?

This modern concept of ESG funds, which we’re so familiar with and hear in reports today, took shape and became the norm in corporate business in the mid-2000s.

However, the principles behind ESG are decades, maybe even centuries, old. It depends on where you draw the line.

So what is ESG investing and what is an example of ESG Investing?

A great example of ESG (Environmental, Social, and Governance) investing is the investment in renewable energy companies, such as those specialising in solar or wind power. For instance, a mutual fund or ETF focused on ESG criteria might include companies like NextEra Energy, which is one of the largest producers of wind and solar energy in the world. This type of investment matches with environmental sustainability goals by reducing reliance on fossil fuels and promoting cleaner energy sources. These companies also often adhere to strong governance practices and contribute positively to social factors by creating ‘green’ jobs and supporting community development.

What is the main difference between standard ESG principles and traditional investing?

Traditional investing delivers value by translating investor capital into investment opportunities that carry risks commensurate with expected returns. Sustainable investing balances traditional investing with environmental, social, and governance-related (ESG) insights to improve long-term outcomes.

And what are the key principles of ESG investing?

The main principles of ESG investing can be separated into to three parts: Environmental, Social and Social. Here they are broken down and what they entail for businesses that would like investment:

Environmental:

Climate change mitigation and adaptation: companies that actively work to reduce carbon emissions and develop strategies to cope with climate change.

Sustainable resource use: those that use resources efficiently and sustainably, such as water and raw materials.

Pollution and waste management: companies that manage their waste effectively and minimise pollution.

Biodiversity conservation: firms that protect and enhance biodiversity.

Social:

Human rights and labour standards: this also includes safe working conditions and equitable treatment of employees.

Community relations: businesses that have positive relationships with the communities in which they operate, including engagement and development initiatives.

Diversity and inclusion: companies with diverse and inclusive workforces and leadership teams.

Customer Protection: those that ensure customer safety and privacy and provide fair products and services.

Governance:

Board composition and functioning: companies with transparent, diverse, and independent boards that effectively oversee management.

Ethical business practices: those with strong ethical standards, including anti-corruption measures and transparent accounting practices.

Executive Compensation: businesses where executive compensation is aligned with long-term company performance and shareholder interests.

Shareholder Rights: Ensuring companies respect and protect the rights of shareholders, facilitating their participation in key decisions.

These principles guide investors in evaluating and selecting companies that are not only financially sound but also contribute positively to environmental sustainability, social responsibility, and good governance practices.

But are there any matters to consider when investing? Yes, absolutely. ESG investing has several pros and cons that investors should consider.

Pros:

ESG factors can help identify potential risks that traditional financial analysis might overlook, such as regulatory changes, environmental liabilities, or social unrest. Companies with strong ESG practices also may be more resilient in the face of crises, such as environmental disasters or social backlash.

ESG-focused companies often adopt practices that can lead to long-term financial performance and stability and can attract investment: as there is increasing demand for ESG-compliant investments, which can drive up the valuation of these companies.

ESG investing can promote better corporate behaviours, leading to broader societal and environmental benefits. Companies with strong ESG practices are often better positioned to comply with current and future regulations, avoiding fines and other penalties.

There is a huge (and growing) consumer and investor preference for responsible companies, potentially boosting their market position.

Cons:

There are always some cons, some subjective, some fact - as this is still a relatively new investment process. For example, ESG data can be inconsistent, incomplete, or non-standardised, making it difficult to compare companies accurately.

ESG ratings can also vary significantly between rating agencies, leading to potential confusion or misinterpretation. Some critics argue that focusing on ESG criteria might limit the investment universe and lead to lower financial returns compared to traditional investing.

It can be challenging to verify the authenticity of a company's ESG commitments and practices. Complexity and Cost has also been noted; incorporating ESG criteria requires additional research and analysis, which can be time-consuming and costly for investors.

The regulatory environment for ESG investing is still evolving, and future changes could impact the viability and attractiveness of ESG strategies.

The market for ESG investments can be volatile, with shifts in investor sentiment or regulatory developments potentially affecting returns.

Taking into account these pros and cons, where should you start? How do you incorporate ESG in your investment strategy?

Incorporating ESG (Environmental, Social, and Governance) factors into your investment strategy is sometimes complex, and involves several key steps:

Firstly, understand the ESG Criteria. Familiarise yourself with the core principles of ESG and how they apply to different industries and companies.

Then set Clear ESG Goals. Define what you want to achieve with ESG investing. This could be aligning with personal values, managing risks, or pursuing sustainable returns.

Create a policy that outlines your ESG criteria, investment principles, and how you will integrate ESG factors into your decision-making process.

Conduct ESG Research and Analysis. Utilise ESG data and ratings from reputable sources to evaluate potential investments. Perform due diligence to assess how companies manage ESG risks and opportunities.

Choose investments that clearly align with your ESG criteria. Engage with companies in your portfolio to advocate for better ESG practices. This can include voting on shareholder resolutions and engaging in dialogue with management.

Monitor and Report on ESG Performance. Regularly review and report on how your portfolio meets your ESG goals, including any improvements or setbacks.