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ESG investing is a term that refers to a growing category of investments that seeks positive returns and long-term impact on society, environment, and the performance of a business. In other words, ESG investing blends environmental, social, and governance factors into traditional investment evaluations with a view towards reducing portfolio risk, generating competitive investment returns, and helping investors put their money where their values are.
How ESG investing works?
To assess a company based on environmental, social, and governance criteria, investors, look at a wide spectrum of behaviors. The following are examples of these behaviors.
The E in ESG stands for environmental, and it is about the impact of a company’s activities on air, land, water, ecosystems, and human health. It can also be used in evaluating any environmental risks a company might face and how the company is managing the risks. Issues under these criteria include disposal of hazardous waste, climate change policies, energy use, and conservation and air emissions as well as reducing regulatory, litigation, and reputational risks.
The S in ESG stands for social, and it is about the impact that companies can have on society. It evaluates how the company treats people. Does it work with suppliers that hold the same values as it does? Does it protect human rights and promote health and safety? Does the company donate a percentage of its profits there or encourage employees to perform volunteer work there? What is its stance on public issues and lobbying?
The G in ESG Standards for governance, and it is about how the way companies are being run. It evaluates how a company uses accurate and transparent accounting methods, as well as how stakeholders are given an opportunity to vote on important issues. It also covers how companies avoid conflicts of interest in their choice of board members and how they manage corporate risk.
The purpose of ESG investing
The purpose of ESG investing is to give investors an opportunity to align their money with their conscience so they can better identify material risks and growth opportunities. The appeal of ESG investing is rising due to the increasing number of millennial who are concerned about the social and environmental responsibility of a company. Multiple studies have shown that a significant number of millennial are more likely to turn down a product or service from a company perceived to be socially or environmentally irresponsible.
5 ESG investing trends to look out for
ESG issues are gaining a lot of momentum as the number of ESG investors continues to climb, and there are a number of critical trend trends you should be aware of.
Climate change becomes a top priority in ESG
According to the World Economic Forum risk map, all top five risks confronting the world today are now climate-change-related, with extreme weather taking the first spot on the list. Experts also believe that there’s a climate angle to the coronavirus and that the disease is the outcome of wild animals losing their habitats due to pollution and deforestation. These issues are forcing companies to transform the way they manage climate-related issues. Hence, we will see more opportunities for investors to profit while also investing in a cause in which they believe.
Though E will remain a top priority, there will be progress on S and G too
While environmental factors will remain the first among equals, there will also be significant progress on S and G. More than ever, millennials will further evaluate how companies treat people within and without while also taking a more critical look at these companies handle issues relating to diversity of board directors, executive compensation, and corporate risk management among others.
Lenders will care more about ESG
Since ESG is not captured in the financial analysis but can affect the profitability of a company, lenders will increasingly use the concept to analyze risk in making corporate loans. Green bonds – those allocated for climate and environmental purposes) will also surge in popularity. As the demand for ESG-friendly bonds rises, financiers will get creative with ways they link ESG criteria to their terms of capital.
ESG is expected to keep outperforming unless oil snaps back sharply
According to several reports, ESG mutual funds have consistently outperformed their counterparts for several years. For instance, nine of the biggest mutual funds in the U.S. outperformed the Standard & Poor’s 500 indexes, and seven of them beat their market benchmarks over the past five years. The trend is expected to continue to outperform, given the continued dreadful performance of energy.
ESG investing is about using ESG as a strategy during a decision-making process to score how well companies address non-financial risks. ESG investing leads to complete investment analysis and better-informed investment opportunities.