What is ESG Investing?

Some investment professionals base investment decisions on more than just the return on investment (ROI). They also look at the impact a company has on the environment, its treatment of employees and the degree of concern it has for customer interest. As an investment strategy, ESG can provide wealth managers, private investors and day traders with access to a segment of the stock market that is focused on either social justice, the environment or both.

Environmental, social and governance (ESG) investing entails investments in companies priding themselves on upholding high environmental and societal responsibility. These companies prioritize financial returns and ensure their products and services don’t adversely affect the environment while maintaining a high regard for their stakeholders. 

How Does ESG Investing Work?

ESG investing is a growing trend among investors desiring returns beyond monetary rewards. These investors prefer to invest in companies that care about the environment, compensate employees fairly and implement policies that ensure customer satisfaction.

At times, companies on Wall Street that take ESG seriously go even further by focusing on human rights, ecological waste management, its own theory of justice, board diversity, the renewable energy industry, shareholder rights and more.

ESG investors possess certain beliefs and invest in these types of companies for several reasons. Keep in mind that several ESG-stye investments are not perfect. Yes, these companies may attempt to battle inequity and lean into social justice, but impact investing cannot address every problem across the globe in a flawless manner.

You may find that a company has taken steps to be environmentally-conscious, but the company may not be perfect. Don’t look for angels. Look for companies that are moving in the right direction and have plans to continue in that direction. You also want to look out for greenwashing because the industry and particular energy companies can easily make claims without evidence. Therefore, you need to know that the ESG investments you choose are actually ESG-focused.

A Company’s ESG Rating is Determined by Third Parties

A third party is responsible for evaluating a company’s ESG commitment. Rating agencies include MSCI, Sustainalytics, Bloomberg and Refinitiv. The evaluation of a company is based on its focus and direction regarding ESG issues. Therefore, socially responsible investing requires a mix of these third parties and your own good sense.

Besides the policies a company has enacted, the third party also analyzes the proactive management of ESG issues. Company scores range from 0 to 100, with 70 and above rewarded to organizations highly dedicated to fulfilling ESG objectives. Certain third parties use letter-based scoring — CCC is regarded as the worst score and a AAA score is for full compliance.

Several Aspects of Environmental, Social and Governance Metrics are Evaluated

Third parties evaluating the environmental components of a company’s contribution examine several factors. They look at a company’s track record for climate change policies, greenhouse gas and carbon emissions, renewable energy usage and recycling and disposal practices, to name a few.

Some of the social factors examined are employee treatment and compensation, diversity and inclusion in hiring, ethical supply chain sourcing and consumer protection activity. Another factor examined is a company’s public stance on social justice issues.

The governance component assesses leadership effectiveness and business ethics. It determines the separation of the chairman and CEO roles, as well as the company’s relationship with regulatory bodies and the transparency of shareholder communication.

ESG Strives for Profits While Meeting Certain Sustainability Report

A common misconception about ESG companies is favoring environmental and social causes over profits. Although ESG companies are held to a higher standard than coal, oil and tobacco companies, they also prioritize profits.

Some investors believe that the policies of ESG companies are detrimental to their bottom line, making them unattractive investments. However, several ESG stocks, mutual funds and ETFs have outperformed the S&P 500. The added benefit of investing in these outperforming funds is that some offer a low expense ratio.

More Companies are Becoming ESG Compliant

The ESG acronym dates back to 2004 when a UN report called for better inclusion of environmental, social and corporate governance factors. At that time, only a few companies could claim to be highly ESG compliant.

Fund managers, asset managers, those saving for retirement and more will look at ESG factors in their investments. However, you must remember that corporations cannot roll out all the best practices for ESG at once. If you’re confident that a company is using ESG criteria to manage itself, you can buy in knowing that it will only get better over time.

In 2020, a global survey found that 81% of companies had implemented a formal ESG program. While some companies haven’t effectively performed against all the ESG metrics, progress has been made. The State of Play in Reporting and Assurance of Sustainability Information reported that only 51% of companies had ESG assurance in 2019. But that number increased to 58% in 2022.

The Environment is the Most Important Element of ESG to Business Reputation

Most compliant companies are determined to improve every element, but it was the environment that proved to be the most important. Germany and France heavily favored the environment over social and governance causes, stating their efforts to be almost 60% when compared to the other two elements, which were in the early teens.

The U.S. and the U.K. have also placed much more importance on the environment than on social and governance issues. The U.S.’s priority was 43% while the U.K. weighed 55% of its total efforts on improving its environmental compliance. 

Benefits of ESG Investing

Companies that are pedantic about having a positive impact on the environment and its stakeholders provide several benefits to investors and the world at large. Let’s get into more detail about those benefits.

ESG Companies May Be a Safer Investment Than Non-compliant Companies

Most investors analyze a company’s financial performance to determine its ROI. Although its finances serve as an effective guide to investors, companies provide more assurance to investors by being ESG compliant.

An ESG company needs to meet stringent standards beyond the scope of finances. It’s also evaluated by ethical policies, employee compensation and environmental impact. Abiding by ESG standards results in companies providing an extra layer of confidence to investors. That reduces the investment risk and makes them a safer investment than non-compliant companies.

Companies Can Increase Profits by Positively Affecting the Environment

Conserving natural resources reduces air and water pollution, providing a healthier environment. But numerous large corporations discovered that environmentally friendly initiatives positively impact their profits.

Apple is a company that has reduced costs significantly by committing to using 100% renewable energy and striving to be carbon-neutral. Its efforts resulted in cutting out fossil fuels and switching to renewables, thereby saving millions of dollars.

A Community’s Standard of Living Is Enhanced

Besides providing a cleaner environment for communities, ESG companies are heavily involved in contributing to charities. Many investors prefer investing in companies aligned with their values, so companies donating funds and products to impoverished communities enhance people’s lives and make investors feel part of philanthropic causes.

Ensures Stakeholder Issues Are Addressed

Third parties regulating ESG companies ensure that executive pay is reasonable and that leadership is responsive to shareholder concerns. They also want to ensure that policies implemented address customer satisfaction.

Customers benefit from the consumer protection policies implemented. Investors receive a certain level of security by investing in a company compliant with the U.S. Securities and Exchange Commission (SEC) and other regulatory entities.

Lower Costs and Better Returns

Several ESG mutual funds and ETFs offer low management fees, which can magnify profits and reduce losses. It’s not only investors that benefit from low investment costs, but companies with sustainable business practices usually lower their costs by avoiding large expenditures on executives and high utility and waste costs.

By lowering their costs, these companies increase profits and provide investors with long-term returns. 

Who Should Try ESG Investing?

Various types of investors and entities benefit from investing in ESG companies. Benzinga lists the types of people that ESG investing would suit.

Investors Seeking High Returns

Companies concerned about high environmental standards are also pedantic about finding the most cost-effective methods of doing business.

These companies regulate executive spending and avoid unethical practices, so they tend to be profitable. Moreover, the management fees for investing in these companies are low, and their stocks tend to outperform the market.  

Individuals Concerned About Social Justice

Large corporations significantly impact societal standards. To change society, individuals need to align themselves with corporations that share their beliefs.

Although these companies have big budgets allocated to social justice causes, they use a portion of share purchases for social justice causes. By buying shares in these companies, individuals support the causes they’re passionate about.

Environmental Activists

Most of the air and water pollution is caused by large corporations. By holding these institutions to high environmental standards, activists get satisfaction by supporting entities that care about the environment.

Activists that own a significant company share may have the authority to set its environmental policies.

Community Boards

The establishment of a company affects numerous stakeholders in a community. Residents are affected by the noise pollution a company may produce and consumers are affected by its pricing.

To ensure stakeholder interests are upheld, community boards can invest in ESG companies to influence policies. An individual investor may not have enough voting power to make a difference, but several community boards with similar interests owning shares will have a louder voice.

Community boards can ensure that a company prices its products and services competitively, employs community members and includes diverse hires, as well as holds executives to high standards. 

Compare the Best ESG Brokers

ESG investing returns are best achieved with a reliable broker that ensures your funds are invested in a high-return, low-expense asset. Benzinga has compared the best ESG brokers.

Looking for Market Insights in the ESG Space

From real estate investment funds to index funds and retirement plans, ESG is an important part of the investment process. This asset category is going to become more and more powerful over time, and you can add these assets to your investment account at any time. Come back to Benzinga at any time to learn more about how publicly-traded assets are challenging everything from the justice system to the energy industry.

Frequently Asked Questions