What is ESG investing?

Environmental, Social, and Governance, or ESG for short, is a framework for evaluating how much a company or investment vehicle prioritises certain societal benefits alongside the normal business objective of maximising profits to shareholders.

Environmental

The E in ESG is concerned with the wider environmental impacts of a business.  Historically there has been a focus on climate change and much of the ESG attention has been on metrics such as the carbon emissions of a business.  This often includes whether a business’ operations are aligned with certain frameworks such as the Paris Agreement, which aims to limit global warming to a 1.5 degree C rise in temperature.  Environmental criteria have become more sophisticated in recent years, and now include things like a company’s waste, pollution, deforestation and impact on biodiversity.

Social

Social considerations include the wider social context of a business, such as whether it provides a safe working environment for its employees, if women and minorities are adequately represented in leadership positions, and whether the company advocates social good in the community.

Governance

Governance is assessed by looking at how a business is run.  Are the accounts transparent and accurate? Is the board acting in a genuine fiduciary capacity for its shareholders?  Governance issues are generally seen as red flags for investors and are often indicative of bigger issues within a company.

ESG Investing

ESG investing is the consideration of these ESG factors alongside financial ones as part of the investment decision-making process.  Although many investors already prioritise ESG benefits at face value, even those who don’t still take ESG factors into some consideration.  This is because ESG factors can carry risk.  For example, investors who might otherwise be willing to invest in coal may be discouraged due to the the risk that changes in legislation or market preference may leave a coal asset stranded.  In this way, ESG factors should be considered by all investors and allocators, even if they are not directly interested in an ESG fund.