In 2004, a former UN Secretary reached out to the CEOs of several major financial institutions with the lofty goal of creating a joint initiative to integrate environmental, social and governance factors into capital markets. The rest, as they say, is history. A mere 8 years later, in 2020, ESG investing soared. ESG products showed a record 140% inflow, and many of the investors were brand new to making investments based on ESG principles. In fact, according to Investopedia, more than half of ESG investors have less than 5 years of ESG-investing experience. But what is ESG investing, what designates an ESG investment, and how does ESG differ from impact investing?
What is ESG Investing?
ESG stands for Environmental, Social and Governance, and is used to support companies that work to make the world better. Although its uphill climb hasn’t always been easy, the evidence is growing that ESG issues have actual financial implications. So much so, that integrating company initiatives with ESG criteria is more often considered a duty rather than a conscientious choice.
~ Dr. Walter Schindler, Forbes, "The Fifth Dimension of ESG Investing"
ESG Criteria
In 2020, the World Economic Forum and the International Business Council began working with the top four accounting firms (the Big Four), to establish a set of 22 criteria. With these criteria, companies were then able to report how closely they were following ESG standards. The 22 metrics have four key areas, and include:
Principals of Governance
Led by Deloitte
- The company includes societal benefits as part of their purpose statement
- Board and stakeholders represent diversity in tenure, gender and ethnicity
- How material topics impact stakeholders
- Employees are trained in anti-corruption, anti-harassment and anti-money laundering
Principals of
People
Led by KPMG
- Equality for gender pay
- Diversity and inclusion within the employee pool
- Rate of injuries and absences
- Training programs provided to employees
Principles of
Planet
Led by PwC
- Report GHG (Greenhouse Gas Emissions) for upstream and downstream
- Disclosing the strategy to mitigate climate risk
- Report on land usage and affect
- Monitor and report on fresh water usage in the supply chain
Principles of
Prosperity
Led by Ernst & Young
- Creates jobs within the host community
- Reports on financial assistance received via grants, subsidies, and so on
- Reporting on community actions and charitable gifts
- Report on how much is spent on research and development for innovative products and/or services
The Difference Between ESG Investing and Impact Investing
ESG investing (also known as sustainable investing) and impact investing are often confused, and rightly so. However, they are pretty different from an investment approach.
Sustainable investments look mainly at the company operations and determine whether they have “positive” Environmental, Social, and Governance (i.e. ESG) metrics or, at the least, no “negative” metrics.
On the other hand, impact investing pays more attention to the actual products and services a company is offering that have a more direct impact in the areas of sustainability and social welfare. An impact investing company still has to have sound environmental, social and governance practices in its operations. However, its focus is mainly on selling solutions, products, and services that help the world achieve its sustainability goals.
ESG Strategies: Aligning Your Morals with Your Wallet
Currently there are 7.8 billion people living on earth and the United Nations World Population Prospects predict that in 2055 this number will reach over 11.2 billion people. Global life expectancy has also improved in recent years, but the earth’s capacity and resources are limited. Global warming, a growing population, political instability, supply chain disruptions and a global pandemic force us to rethink towards a more sustainable way of living. To achieve a sustainable future, we need to find a way to meet our current demands while protecting the environment and our resources for the future.
Many investors are no longer interested to only invest in companies from a profitability standpoint, but also from a values standpoint. Experts believe ESG to be the tool:
“…that is the roadmap that is going to allow investors and society more broadly to hold companies to account, to make sure that the issue we care about through society – be it social justice, be it inequality or diversity or whatever it may be – are actually reflected in the companies that we’re investing in”.
CNBC, Investment in ESG ‘should at least double’ this year, researcher says
What to Look for When Choosing an ESG Investment
1. Familiarize yourself with the terminology and do some research
Educate yourself about some of the acronyms and terminology you are likely to see in the investing sphere. There are many different ways to participate in clean investing – from index funds that screen out companies according to certain criteria to venture capital funds that finance social enterprises. Having a basic level of knowledge of the terminology will help you evaluate your choices and figure out what makes sense for you. As an example, understanding the difference between ESG investing and impact investing.
2. Understand the investing spectrum
To help make investment decisions it is important to know where you stand, or where you would like to stand on the investment spectrum. An impact investing firm has developed the following spectrum to help new investors visualize the varying approaches to ESG and impact investing depending on the impact and financial goals of the investor.
Types of ESG Investments
As mentioned above, environmental, social and governance criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. ESG-minded business practices have gained more traction and investment firms are increasingly tracking their performance, providing different options for investors.
Equities
Green stocks are becoming more competitive due to the growth of climate awareness, advancing technologies, and low cost of cleantech.
Bonds
Projects that are funded by green bonds are focused on energy efficiency, pollution reduction, transportation and innovative green technologies.
Exchange-traded Funds
ETF are investment funds that are being traded on stock exchanges, much in the same way as stocks
Hedge Funds
The demand for impact investing is higher than ever today and continues to grow. At Transformation, we are taking the opportunity of this demand to create sustainable and high-impact projects in the areas of energy, water, agriculture, and technology.
How does a strong ESG proposition make financial sense?
With the increasing awareness of environmental issues and the impacts of climate change many investors are interested to seek out investments that do some good to the world while providing profitable returns.
According to Mckinsey, a strong environmental, social and governance proposition links to value creation in five essential ways:
1. Top-line growth
A strong ESG proposition helps companies expand into new markets and stay competitive in existing ones. “When governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford fresh opportunities for growth”. For example, in a recent, massive public-private infrastructure project in Long Beach, California, the for-profit companies selected to participate were screened based on their prior performance in sustainability.
ESG can also impact consumer preference. Recent studies have shown that consumers are willing to pay “to go green”.
2. Cost reductions
ESG can also help with significantly reducing costs. “Among other advantages, executing ESG effectively can help combat rising operation expenses (such as raw-material costs and the true cost of water of carbon”.
3. Reduced regulatory and legal interventions
According to a study by Mckinsey, a stronger external-value proposition can enable companies to achieve greater strategic freedom, easing regulatory pressure. In fact, in case after case sectors and geographies, we’ve seen that strength in ESG helps reduce companies’ risk of adverse government action. It can actually help achieve government support.
4. Employee productivity uplift
A company with strong values and a thought-through ESG proposition attracts and retains quality employees by enhancing their motivation and giving them a sense of purpose. Several studies show that employee satisfaction is positively correlated with shareholder returns.
5. Investment and asset optimization
A strong ESG proposition “can enhance investment returns by allocating capital to more promising and more sustainable opportunities (for example, renewables, waste reduction, and scrubbers). It can also help companies avoid stranded investments that may not pay off because of longer-term environmental issues (such as massive write downs in the value of oil tankers)”. Source
The demand for ESG-/ impact investing is higher than ever today and continues to grow. Businesses and investors must develop better ways to assess social and environmental impact. At Transformation, we are taking the opportunity of this demand to create sustainable and high-impact projects in the areas of energy, water and agriculture, and technology. We are dedicated to helping clients make strategic investment decisions in a unique, innovative way.
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