In our modern world, investing has become more than just seeking financial returns. During the past couple decades, there has been an increasing number of investors, institutional or individual, who want to invest their money in projects that will benefit the world they live in, whether it be in their own community or globally.
How can individual investors leverage investment opportunities to support the things they care about while seeking financial returns?
Due to the difficulty of measuring the impact of a company on its local and global community, a set of standardized factorscriteria have been established by the United Nations that may help generate long-term competitive financial returns and positive social impact for companies. This set of standards is called ESG, which stands for Environmental, Social, and Governance issues.
ESG Explained
ESG is used by companies and organizations globally to help them generate more than just financial returns. This term has three broad subcategories.
Environmental:
The environmental category helps companies measure their impact on the environment, which includes factors such as water use, natural resources, pollution, climate change, carbon emissions, and many other environmental factors.
Social:
The social category helps companies measure their impact on the communities they’re a part of or impact in one way or another. Some factors for this category include human rights, community development, Diversity Equity and Inclusion (DEI), workplace benefits, labor relations, and workplace safety.
[Corporate] Governance:
The governance category refers to corporate governance and it helps companies govern their internal systems as well as external relations. Some factors in this category include political contributions, executive compensation, board diversity, anti-corruption policies, and board independence.
Criteria
According to US SIF Foundation, the figure below shows the most important ESG criteria for money managers in 2020, like:
- Climate Change/Carbon
- Anti-corruption
- Board Issues
- Sustainable Natural Resources/Agriculture
- Executive Pay
Benefits
ESG has helped companies gain a more holistic view of their performance and investments. It has not only been helping create more positive social returns, but has also been proven to help in increasing the financial returns of companies as well. According to the Harvard Law School Forum of Corporate Governance, there are numerous benefits for companies who have higher/more favorable ESG Corporate Rating Performance. These benefits include:
1) Positively correlated with valuation and profitability
2) Negatively correlated with volatility
3) Less cyclicality in performance and lower risk
4) Creation of long-term value
A McKinsey report written by Witold Henisz, Tim Koller, and Robin Nuttall, discusses other benefits that high-performing ESG companies have. These include cost reductions, less regulatory and legal interventions, employee productivity uplift, and asset optimization.
According to Five ways that ESG creates value (McKinsey Quarterly, November 2019), the figure below shows how ESG proposition create value in 5 ways.
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Strong ESG proposition (examples) |
Weak ESG proposition (examples) |
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Top-line growth
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Atract B2B and B2C customers with more sustainable products
Achieve better access to resources through stronger community and government relations
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Lose customers through poor sustainability practices (e.g., human rights, supply chain) or a percpetion of unsustainable/unsafe products
Lose access to resources (including from operational shutdowns) as a result of poor community and labor relations
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| Cost reductions |
Lower energy consumption
Reduce water intake
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Generate unnecessary waste and pay correspondingly higher waste-disposal costs
Expend more in packaging costs
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| Regulatory and legal interventions |
Achieve greater strategic freedom through deregulation
Earn subsidies and government support
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Suffer restructions on advertising and point of sale
Incur fines, penalties, and enforcement actions
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| Productivity uplift |
Boost employee motivation
Atract talent through greater social credibility
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Deal with "social stigma," which restricts talent pool
Lose talent as a result of weak purpose
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| Investment and asset optimization |
Enhance investment returns by better allocating capital for the long term (eg., more sustainable plant and equipment)
Avoid investments that may not pay off because of longer-term environmental issues
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Suffer stranded assets as a result of premature write-downs
Fall behind competitors that have invested to be less "energy hungry"
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As individual investors or curious learners, it is essential to know what ESG is and how companies with higher ESG ratings have been performing compared to ones who may score lower on ESG criteria. Some factors to consider as an individual investor when looking to companies include:
- Your investment goals
- Your values
- Company impact on the world around it
- Your brokerage and accessibility to a wide range of companies
- Doing Research and staying informed on ESG news
Learn More
If you’re interested in learning more about ESG and ethical consumerism, feel free to watch our Conscious Consumerism webinar recording or complete the module in the Spend course.
You can also register for our upcoming How Your Spending Can Change the World webinar on March 29, 2023.
