Understanding ESG Investing

Understanding ESG Investing

NAV TL;DR

If you don’t have time to read through the whole article, you can check out our short version below.

  • 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.

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.

Environmental factors

Understanding ESG Investing

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

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?

Governance factors

Understanding ESG Investing

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?

In Summary

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.

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