In the contemporary world, a company’s bottom line doesn’t always mean its profit or loss for the year. Now, there is a new dimension to it i.e. ESG- Environmental, Social, and Governance.
Environmental, Social, and Governance (ESG) have emerged as more than a responsibility. Sustainability is the key here. An ESG program creates a valuable impact for the organization, community, and for the planet for years to come. A strong ESG program ensures that there is a vision set for an organization’s environmental and societal influence. This provides value internally and externally both.
A triple bottom line cares about people, the planet, and profits. If you want to do well by doing good, you may want to invest in ESG.
ESG criteria are a set of standards for a company’s behavior pertaining to socially conscious investors. Environmental criteria are basically about how a company safeguards the environment. This includes corporate and business policies addressing climate change. ESG is so important today because matters of business and the environment are interlinked with each other and with the current set of conditions of the Covid-19 pandemic. ESG has acquired greater importance among investors and policymakers. It is seen as a way to protect the business from future risks.
Environmental factors
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Environmental factors include how a company or government contributes to making climate change. This is through greenhouse emissions, waste management, and energy efficiency. Looking at the current scenario to combat global; warming, cutting emissions, and decarbonizing are becoming more important.
Social factors
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Social factors include human rights, illegal child labor, gender issues at the workplace, and also workplace issues like health and safety. A social dimension also arises if a company is well connected with its local community. And also has a social license to work with consent.
Governance factors
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Governance means rules or principles. These rules or principles are with regard to rights, responsibilities, and expectations between different stakeholders in governance. A well-defined corporate governance system can be used to connect with interests between the stakeholders. It can work as a tool to support a company in the long term when it comes to strategy. Governance also refers to standards of the government of nations.
Merits of ESG investing
⦁ Invest for the future
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If you are investing in environmentally and socially conscious companies then you are obviously avoiding harm. Publicly-traded ESG companies have the resources that allow them to create a pro-social future. These companies can positively influence the international corporate market. They can produce products and services that serve humanity.
⦁ Build a portfolio that keeps you invested in tough times
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Overtrading can be harmful to wealth. Investors do best when they buy and hold over the long term. But sticking to a portfolio allocation can be tough. Investors use all kinds of shortcuts to avoid eroding their wealth through common mistakes. If ESG investors believe that their portfolio is bringing positive social impact, they may be more likely to stay invested in the long term.
⦁ ESG investing can produce returns at par with or just like traditional investing
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Investors may worry that ESG investing can produce suboptimal outcomes. But there is enough evidence that shows that ESG investing can be as profitable as passive investing. So, ESG is a good option.
Demerits of ESG investing
⦁ You may pay a ‘Greenium’
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Fees and expenses are the rivals of performance returns. ESG funds carry higher than average expense ratios. This Greenium can lead to some underperformance- like especially compared to the very low expenses that index fund investors have to pay.
⦁ You have to pick your issues
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No company can be strong on every ESG dimension. Some promote women in leadership areas, others reduce pollution and carbon emissions. Some companies do everything in a good way. And most companies choose to tell about their most impressive records.
Even if clear dimensions of ESG efforts exist, but still investors would have to choose the issues they care about. A company may hold a strong record of women in leadership positions, but an over-index on pollution and carbon emissions. Another may have a strong environmental record but can have poor employee-management relationships.
Ensure that what issues are most important to the fund manager. If those values connect with yours, then the fund or the platform may make sense to you.
⦁ No clear Environmental, Social, or Governance standards
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The Securities and Exchange Commission (SEC) requires companies to report certain metrics and dimensions. But still, the governance of ESG metrics is loose. Consequently, every company manages its own ESG reporting. There is work going on to establish international environmental standards, but the work is slow. In actuality, investors must depend on company-defined metrics. These are both credible as well as non-credible. They may spill over some bad business practices.
You either need to abide by what your fund manager says, or you will need to spend a lot of time researching individual companies to add their metrics.
⦁ You may become less diversified: a lack of diversity
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As an ESG investor, you can invest in any sector of the economy. But you run the risk of becoming less diversified due to the ESG standards. For example, a person who requires a strong record of women and minorities in leadership positions at leadership levels may find lesser U.S. stocks in their portfolio.
Managing appropriate asset allocation becomes important if you are an ESG. Using a portfolio analysis tool can be helpful in keeping track of your portfolio.
Conclusion
At the core of ESG investing lies the concepts of sustainability and profitability. Many business experts say that it is possible to achieve both simultaneously. The rise of ESG investing has had a significant impact globally. ESG refers to the three central factors that are there in the sustainability of an investment. It simply means how far advanced they are with sustainability. ESG is the 9th most important criterion when determining as to if one will buy a company’s products or services. ESG is the 5th most important factor when it comes to the recommendation of a company.
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