Understanding ESG investing
If you’ve only got a minute:
- Socially responsible investing is gaining traction among the broader investment community
- One of the popular ways of doing so is by evaluating Environmental, Social, and Governance (ESG) factors when making investment decisions
- You should always do your due diligence when investing along ESG lines as even the most socially responsible companies are not perfect
Like the greater society, the investment community is placing a larger emphasis on being socially responsible. They are relying more on non-financial metrics in the investment decision-making process to sieve out companies that bring positive change to the community and economy. Some of these examples are easily measurable while it might be hard to place monetary value on others.
In the past, socially responsible investing was said to sacrifice profit but there is growing literature suggesting that socially conscious companies can be more profitable.
Previously a niche theme, ethically driven investing is now mainstream, driven by a focus on Environmental, Social, and Governance (ESG) factors.
Investment professionals, governments, financial institutions, and retail investors are using ESG metrics to assess, measure and compare companies when making investment choices.
There are even data providers that compile ESG scores of various businesses. DBS adopts MSCI ESG Ratings (which cover equities, bonds and funds) to provide clients with greater transparency over the ESG characteristics of their investment portfolios.
Companies too, have stepped up. While there is currently no standardised manner for reporting ESG metrics – they are typically not mandatory in financial reporting – more companies and funds are making such disclosures through annual reports or in separate sustainability reports.
ESG factors are interconnected and there is no all-encompassing list of ESG examples. This might present some difficulties in classifying an issue exclusively as an environmental, a social or governance factor.
That said, you are still able to ascertain whether a company is on the right path through researching on where its business practices fare along ESG issues. Here are some considerations you can take note of when assessing a company along ESG lines.
Many of us are familiar with environmental issues like climate change and air quality, among others. Do note that as much as some business practices can affect the environment, others are able to preserve or rejuvenate the environment.
Areas that tend to be covered under the environment component of ESG investing include biodiversity, carbon emissions, type of energy use, waste management, water pollution and treatment of animals.
Here are some questions to ask yourself:
- How large is a company’s carbon footprint?
- To what extent does a company use renewable or green sources of energy?
- If a company is in a high carbon footprint business, does management have clear targets to lower them?
- How does a company manage the disposal of hazardous waste?
- Are operations in compliance with environment regulations?
Social factors usually look at the company’s internal and external business relationships.
Areas that tend to be covered under the Social component of ESG investing include community relations, customer satisfaction, data protection and privacy, employee diversity, employee engagement, human rights records and labour practices.
Here are some questions to ask yourself:
- Is the labour force at production facilities fairly paid and not exploited?
- Does a company place a strong emphasis on workplace health and safety?
- Does a company encourage employees to take part in community engagement efforts?
- Are a portion of profits donated to local charities?
- How well are customers protected from data breaches and misuse of personal information?
Criteria in this area usually covers a company’s corporate governance.
Areas that tend to be covered under the Social component of ESG investing include boardroom diversity, audit practices, executive compensation, employee compensation, corruptive practices, and presence of whistle-blower schemes.
Some questions you can ask:
- Does appointment of board members result in conflicts of interest?
- Are accurate and transparent accounting methods used?
- Does a company use political means to receive preferential treatment?
- Are there recent or ongoing cases related to workplace discrimination?
- Are minority shareholders given ample avenues to voice their concerns?
Sustainable investing strategies
We have already covered that sustainable investing involves making investment decisions using traditional financial factors together with ESG factors. The next question that comes to mind is what strategies an investor can take to invest sustainably.
This can be done through sustainable investing strategies, of which, the 4 most common are:
- Negative/exclusionary screening
- Positive/best-in-class screening
- ESG integration
- Sustainability themed investing
1. Negative/exclusionary screening
Through negative or exclusionary screening, investors will exclude certain sectors or companies from an investment portfolio based on ESG criteria or their ratings. An example of this is the avoidance of investing in companies that are in the trade of producing weapons or those with a clear track record of human rights violations.
2. Positive/best-in-class screening
By adopting positive or best-in-class screening, investors include sectors, companies, or projects that are "best in class" on specific ESG ratings compared to their industry peers. This includes looking for companies with current high ESG scores/ratings or favouring those that have been actively improving their ESG scores over time.
Unlike negative screening, which may exclude entire sectors or companies, positive screens may include top performers operating within industries with low ESG scores. An example of this is investing in an upstream oil and gas company that beats its peers in ESG ratings, despite the broader industry having a less than average record on the ESG front.
3. ESG Integration
This strategy involves proactively including ESG factors into financial analysis to identify risks and opportunities when investing in a company. An example of this includes DBS' Discretionary Portfolio Management team incorporating ESG ratings in portfolio construction, augmenting traditional analysis without compromising on portfolio returns.
4. Sustainability-themed investing
This involves investing in companies or sectors that are related to sustainability such as investing in a fund that is focused on renewable energy or sustainable agricultural practices.
It is important to know that companies – even the most socially responsible ones – are not likely to tick all the boxes. Bear in mind that there is still no unified standard for judging ESG performance by companies and there could be cases of false reporting of ESG measures.
This is why it is crucial for you to conduct your own research and decide which issues mean most to you.
On top of making socially responsible investments, you can also also consider doing so in other ways. DBS has a suite of green products and solutions that fit into different aspects of your life — from your home to your daily transport and purchases, to investing for the future. They are all made simple for you to save more and waste less.
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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
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