The average investor has shown an increasing concern about the effects of climate change on the environment and how it affects them. The other two letters have also gained in importance, consider the social implications of poor labor standards, gender and diversity, supply chain issues, and governance with matters like lax governance standards.
Most of us have already altered our behaviors on a personal level and have applied certain values by recycling, composting, shopping locally, avoiding certain stores or brands or even country of origin. Well now investors can also have an impact on companies with their investment dollars because of ESG and even those investors who question the validity of investing in that manor still benefit from it.
What are the main ESG criteria in investing?
Investors are familiar with the Balance sheet, Income statement and how analysts consult these pages and from them calculate ratios and price targets using that information. ESG investing adds another layer of non-financial qualitative factors as part of the analysis process. It complements traditional financial analysis with the goal to identify material risks and growth opportunities. Below are a few criteria that can be considered:
| Environment | Social | Governance |
|---|---|---|
| Climate change | Inclusion and diversity | Board composition |
| Carbon emissions | Human rights |
Executive compensation |
| Air and water pollution |
Health and safety |
Investor relations |
| Biodiversity |
Community relations |
Lobbying\political contributions |
| Natural resource management |
Labor standards |
Corruption |
| Waste management |
Data protection |
Accounting standards |
| Energy efficiency |
Employee engagement |
|
| Source: National Bank Investment | ||
Many of these factors when taken into consideration can have a direct impact on a company’s financial statements whether positive or negative. Improving efficiency, reducing waste are an easy win for companies that will have a positive impact on their earnings. Under the social category companies that apply these factors are rewarded with higher employee retention or an easier recruitment which can translate into millions of dollars of annual savings for a company. From a governance standpoint one of the benefits will be increased transparency & disclosure which can shed light into accounting issues, possible corruption and poor governance practices. Another goal is the alignment of interests between executives and shareholders.
Understanding the ESG umbrella
Many differing terms are used to describe this investing trend, so a little explanation is warranted. Firstly, ESG are criteria that a conscious investor can use to analyze securities. It will result in the assigning of a score indicating a high or low risk rating or a poor or best in class practice. The goal of this approach is to better identify and understand the risks involved and manage them accordingly. Secondly, it also means being a responsible shareholder by entering into a dialogue with the company’s management on ESG issues and trying to resolve them. It also means exercising voting rights to effect change.
What is Ethical Investing?
Is the practice of selecting investments based on ethical or moral principles. When the first ethical funds came out in the 1970’s, they would exclude companies, sectors or even countries that are not compatible with their values.
What is Responsible Investing (RI) or Socially Responsible Investing (SRI)?
Refers to the integration of ESG criteria in the selection and management of investments by improving risk management, long-term financial performance and contribute to positive social change. In this scenario, an investor could potentially hold shares of companies in the energy & material sectors, but they would be leaders in their class based on ESG criteria. Basically, an investor would work with and challenge companies to address their ESG issues and invest in those that are making changing and embracing this trend while not investing in those that aren’t.
What is green investing?
Green investing can fit under the SRI umbrella but tend to target organizations that have a positive impact on the environment.
What is impact investing?
Impact investing is also derived from responsible investing. It is to invest in compagnies that have a favorable impact on social and environmental change while generating a financial return, for example a company that produces cruelty-free products. The choice of investing in these companies is often linked with the investor’s values.
What is Sustainable Investing?
Investing in securities that contribute to the achievement of one or more of the 17 United Nations sustainable development goals1 such as to combat climate change, environmental destruction, clean energy and others while promoting corporate responsibility. It’s about investing in progress and recognizing that companies that provide solutions to today’s problems can be best positioned to continue to grow in the future.
Self-directed investors need to decide what type of goal they wish to achieve when trying to impact and support positive social or environmental outcomes with their investment dollars. There are plenty of ESG type ETFs to choose from for every investor and for every risk tolerance.
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1 United Nations: https://www.un.org/sustainabledevelopment/sustainable-development-goals/