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ESG Investing: A Beginner’s Guide to Environmental, Social, and Governance Investing

ESG investing

Environmental, Social, and Governance or ESG are essential parameters of an analysis of their efforts to add sustainability to an organization. In short, ESG is all about making a difference in the planet, for people and organizations. An excellent ESG practice in a company will attract investors to take notice of your organization for ESG investments. If you are wondering how can an organization embrace its sustainability or whether I can invest in ESG-focused companies? Or what is ESG investing? You have visited the right place! 

Environmental factors look after the factors that concern conversing with the natural world, social aspects are for evaluating how a company treats people inside and outside of its organization, and Governance factors tell us an overview of how a company is run. Sounds interesting? This blog is designed to guide you on every aspect of ESG investments and give you insight into creating a robust ESG portfolio. 

Let us give you a quick roadmap on the vital factors of ESG investing

  • What is ESG investing
  • How do ESG investments work?
  • Why is ESG a trendy option in the US?
  • The vital ESG categories
  • How can an organization earn ROI on ESG
  • Ins and outs of ESG scoring
  • Perks and Drawbacks of ESG Investing
  • How to select the best ESG-backed investments
  • Bottom Line

What is ESG investing?

Environmental, Social, and Governance entail several factors that examine how a company's activities and practices contribute to sustainability, and how it manages to reduce the negative impact on the planet and its people. In short, ESG investing is a form of financial investing that judges environmental, social, and governance factors to analyze investment returns and their impact. 

The ESG score of sustainability determines investment scope in the above-mentioned ESG categories. There are $8.4 trillion in sustainable investment assets as per Sustainable Investing Overview by US SIF Foundation 2022. Not just that, ESG investments measure the accountability and transparency of an organization and act as a tool to determine whether a company is financially stable and reliable for investing. 

One of the key ESG categories investors look for in an organization includes:

  • How do the activities practiced by an organization reflect society?
  • How much does an organization care for environmental concerns?
  • How well an organization is run considering laws, accounting, and more

Let us walk you through detailed topics included in Environmental Social and Governance 

Environmental Social Governance
Direct and indirect greenhouse gas emissionsFair OpportunitiesExecutive Payment
Resource DepletionRelations with employeesManagement structure and diversity
Climate change aspectsWorking conditionsEthics of Organization 
Carbon emission from fossil fuelsFair and deserved wagesStructure and diversified board
DeforestationHealth and safety concernsInvestment options
Pollution and waste managementEmployee diversity, equity, inclusion and belongingCorruption
Animal WelfareChild labourDiligence and compliance
BiodiversityModern slavery issuesTaxation Strategy
Energy and water efficiencyHuman rightsPolitical contributions

Environmental, Social, and Governance is an advanced version of CSR (Corporate Social Responsibility). CSR is a strategy or individual activities that an organization runs to contribute to sustainability, for instance, internal green practice, and more. 

ESG takes responsibility for practicing all the factors mentioned above in the tables and assesses investors, and consumers whether an organization is worth considering investing in by looking at its growth, sustainability, and willingness of a company to take risks. 

The Detailed Process of Environmental, Social, and Governance 

If you are still wondering what is ESG investing? To simplify it for you, ESG is also termed as:

  • Ethical Investing
  • Socially responsive investing
  • Sustainable Investing

In recent years, ESG investors have been increasingly looking for investment sources where their values align with the company's core values. The good news is, many financial and investment companies have begun offering exchange-traded funds (ETF), mutual funds, and more financial products that meet with the ESG investments strategy. What’s more? Robo-advisors including Wealthfront and Betterment have been offering ESG-based investments to young ESG investors today. 

According to the report of the US SIF Foundation, ESG investors have held 17.1 trillion dollars in chosen assets as per ESG principles 2020, up from 12 trillion dollars just in the last 2 years. ESG-specific mutual funds and EFTS have grown to a record $ 400 million in AUM 2021, 33% up from the previous year, and as per officials, it is expected to grow more shortly. 

Note, to assess the growth data of a company, investors look for criteria like the organization’s policies and behavior towards the planet and more. 

Why is ESG a Trendy Investment Option in the USA?

The times when people and organizations disregarded environmental and social causes have been fading drastically. In Modern times, an organization’s value is evaluated not only by what it does but how it offers its products or services. ESG investors, employees, consumers, and legislators expect an organization to tread or lead the world lightly by considering environmental and other factors. 

The shocking and hard fact to digest is that it is estimated by officials that by 2026, climate change-related events would cost 1.3 trillion dollars in organizations. This estimation has attracted and encouraged many individuals and investors to consider ESG factors. 

Without a commitment to change, organizations won't bring sustainability and prosperity into the world. Many organizations are deciding to choose sustainability as a priority not only because it's good for the planet, but ESG strategy is prone to maximizing revenue to organizations as young investors and Gen Z have become conscious of their buying method, they prefer buying products that work for solving environmental or other issues. 

However, ESG funds are quite different from traditional funds. Why? 

  • Because measure financial performance, and stability in the market
  • Investing in organizations and industries that meet ESG factors. 
  • Constantly evaluate an organization's performance to check sustainability.

The Vital ESG Categories for Investment

There are multiple options for ESG investments, but let’s head towards the most popular alternatives. 

ESG Mutual Funds

As we discussed above in the blog, the number of mutual funds in the ESG industry has surged in recent years. According to the reports of Morningstar, there were a total of 303 open-end exchange-traded funds (ETF) in 2019, rising to 270 in 2018. 

Some of the funds specifically focus on green energy, which benefits investors to customize their ESG portfolios based on their area of interest. And, if your broker allows you to have access to a screening tool, you can easily evaluate and observe how ESG funds stack up. 

If you want to learn the details of specified funds or options to invest in, you will have to look around the prospectus. The document is available on the website of your broker and offers essential details like the expense ratio of the funds. 

ESG Funds

Instead of holding a portfolio on one or two companies with high percentages, a few investors prefer to select ESG investing stock in a company they believe has the potential scope to grow in the future. Certain companies provide impact reports highlighting culturable or sustainable initiatives that a company has implemented and how they have managed environmental and social issues. 

If you want to have access to the score of an organization regarding environmental factors, you can check third-party sites such as Glassdoors. You can also look at the more specified factors such as revenue and net income with thorough research. 

Read Also:- A Complete Guide to Building a Strong Financial Foundation

How Can an Organization Earn ROI on ESG?

Environmental, Social, and Governance investments are known to be healthy and profitable investment sources. ESG funds deliver healthy financial returns on investment in different possible ways. 

Maximized Brand Awareness and Value

There is a direct link between the brand's value and the organization's sustainability initiative. Customers are actively looking for organizations that hold or practice ESG factors and contribute towards the betterment of the world. 

According to the data of Bain and Organization, companies that scored higher ESG scores have observed 5x more revenue and overall growth comparatively. 

Attracts more customers

Customers are very selective about spending their money, and the decision to invest their money in an environmentally and socially responsible organization varies on individual preferences and values. 

As per the research by Forbes, 62% of the young generation prefer buying products from sustainable brands, whereas 87% of consumers like to invest their money in a company that works for a cause that they believe in or support. Brands can tie closer connections with the community when they solve the problem that matters to the consumer. 

Top-line business growth

By offering reliable sustainable products, companies can target more B2B and B2C customers. When a company has good corporate governance, sustainability, and social responsibility at its core, an organization tends to grab the attention of consumers and make great investments. 

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Ins and outs of ESG scoring

There are innumerable grading systems for Environmental, Social, and Governance investment, two eminent scoring methods include - Bloomberg ESG Scores, one of the convenient options for organizations rates varied companies from 1 being the worst to 100 being the best. The second scoring method is MSCI ESG Rating, which uses rules-based methods to recognize industry leaders and laggards. 

The MSCI ESG Rating system measures a company’s scope on its ESG risk factors and how well they manage the risk. The ratings or scoring in the MSCI method ranges from (AAA, AA) as leaders to ( A, BBB, BB) as average and ( B, CCC) as laggards. MSCI ESG Rating methodology measures equity, fixed income security and EFTs, mutual funds, and more. 

As per InfoGrind, most of the ESG ratings occur with 1 being the worst to 100 being the best. Organizations that score 70 are considered the best ESG organizations, whereas a few organizations prefer a letter base scoring method. 

Let us dig in deeper and learn more about ESG Scoring. 

Excellent

An organization with a score of 70+ is considered to have the best ESG practice and has very few internal and external risks. 

Good

When the organization's ESG practices are good but have a low impact on the environment or people it is graded as good. 

Average

When an organization is unable to meet the ESG benchmarks or achieve ESG targets is considered an average score. 

Poor

When an organization is graded 50 or below is termed as poor scoring. Here, the organization does not practice ESG factors and hurts the environment, does not treat employees or suppliers well. 

An excellent ESG score is an attractive ESG investing stock or funds or investors as it includes:

  • Great brand image
  • Good relations with stakeholders
  • Lower turnover
  • Engaged employees
  • Lower liabilities and ESG issues

Whereas, a poor ESG-graded organization indicates:

  • The rising poverty line in the organization
  • Disregarded employees with health, and lowe DEIB
  • Higher ESG liabilities
  • Higher employee turnover

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Perks and Drawbacks of ESG Investing

ESG investing is a hot topic today, as the majority of investors are gradually becoming conscious of the organization's initiatives toward the planet. Based on ESG factors a company is judged to determine financial investment return and its potential growth. If you are still perplexed about investing in ESG, we are listing a few perks and drawbacks to help you give an overview. 

ESG PerksESG Drawbacks
ESG investment leads to investing in ethical practices by brands. Sustainable funds tend to give better returns than traditional funds
ESG cannot be used as a marketing tool, organization needs to believe and be authentic while embracing ESG initiatives within and outside the company. There's no specific ESG manual to follow, an organization needs to fit ESG strategies to their company values. 
ESG practices are known for overall cost-cutting like reduced operating system expense, recruitment and waste cost that a company invests in.  ESG has rapid growth in the market. Customers are attracted toward organizations that promote sustainable products and services with higher ESG ratings.
While ESG organizations tend to perform strongly in the ESG investing stock market, the result isn’t guaranteedESG funds fees are higher than traditional fees, as corporate managers need to do thorough research for ESG factors that align with the organization’s values. 
ESG based organizations also perform on top in the ESG investing stock market. They are known for taking risks on longer terms, and are a safer option for investors. While ESG organizations tend to perform strongly in the investing stock market, the result isn’t guaranteed

Read Also:- The Power of Compound Interest: Making Your Money Work For You

How to select the best ESG backed investments

To begin with, investors and individuals can refer to the scoring methodology that we discussed to evaluate the potential growth and credibility of an organization while considering ESG investments. 

MSCI's scoring method has more than 8,500 companies worldwide that use a letter-based grading system to organize by judging their sustainability initiatives. Other companies like Morningstar, have also come up with their scoring method that aids in understanding the organization's brand value and simplifies examining ESG in finance factors. 

Bottom Line

Investors are eagerly looking for aligning their portfolios with companies that practice ESG factors. It's one of the exciting areas for young investors with a positive impact on the environment. 

If you are wondering whether ESG funds are the right investment option for you, it entirely depends if you want to align your values with your ESG investing options. For your research, you can consider the company's scores based on different methodologies discussed in the blog for your understanding. 

Frequently Asked Questions

Q.1 What ESG strategy is important for companies?

By focusing on ESG strategy, organizations, and stakeholders enjoy a few benefits like improved investor and public relations, enhanced financial company [performance, overall cost cutting, and managing risk efficiently. 

Q.2 How do ESG activities reduce an organization’s expenses?

ESG in finance activities have many benefits to organizations, but one of the top perks remains cost-cutting in various ways like sustainable practices and reducing energy usage, and water usage.

It also reduces the cost of packaging for products and puts limitations on the waste your company produces. In-house expenses, companies reduce major expenses by reducing employee turnover and attracting more employees to retain potential exciting opportunities with a better brand image.