The goal of every investor is to maximize return on investment, which means searching for investment vehicles that offer the most significant reward for the lowest cost and risk. However, that doesn’t mean that we leave our ethics and values at the door when making investment decisions. All things being equal, most of us would choose investments that reflect our values. ESG investments allow investors to consider non-financial factors in creating and carrying out an investment strategy, selecting investments that reflect a commitment to environmental sustainability, human rights, and good corporate citizenship. Learn more about how to invest in your values by including ESG investments in your portfolio.
What Are ESG Investments?
ESG stands for environmental, social, and governance. Also known as sustainable or socially responsible investing, ESG investing includes considering non-financial sustainability factors when selecting an investment, allowing investors to choose products that promote social responsibility and good practices. An investment’s ESG rating or score analyzes a company’s resilience in the face of long-term environmental, social, and governance risks. Based on those factors, it can help investors evaluate both a company’s ethical practices and its safety as a long-term investment.
This analysis attempts to paint a comprehensive picture of an organization’s commitment to eco-friendly practices, favoring investments that place a high priority on environmental sustainability. ESG evaluators look at a company’s ecological practices to evaluate environmental sustainability. These practices include carbon emissions, air and water pollution efforts, green energy initiatives, waste management, recycling practices, and water management practices. The analysis may also evaluate organizational policies practices designed to encourage employees’ sustainable practices, such as carpooling or public transportation incentives.
The analysis of an organization’s social practices focuses on its employment practices, relationships with the community, and commitment to human rights. This prong of the study looks at workplace safety, employee diversity, the company’s track record of data security, and commitment to fair labor practices in the United States and abroad.
Governance factors account for the compliance, compensation practices, and distribution of responsibility for the day-to-day management and governance of the company. In addition to allowing investors to screen for companies that manage sustainably and responsibly, an analysis of the governance factors can also help investors assess an organization’s future risk for losses associated with mismanagement. The governance prong of the study focuses on a company’s corporate governance and compliance, including diversity of board members, political contributions and lobbying, executive compensation, and history of corruption or bribery.
How Are ESG Ratings Calculated?
There is no single accepted metric or source for calculating a company or organization’s ESG rating, as each rating organization applies slightly different criteria. Organizations such as Morgan Stanley Capital Investments (MSCI), S&P Global, and Morningstar provide ESG ratings for companies, funds, and even countries. In addition, many companies offer self-reporting on sustainability practices and ESG factors according to the factors established by the Global Reporting Initiative (GRI) or the United Nations Principles for Responsible Investment (PRI). Other analysis tools are provided by organizations such as the Task Force on Climate-related Financial Disclosures (TCFD) and EcoVadis.
Because ESG reporting can vary from company to company or rating agency to rating agency, it is often left to investors and advisors to sort through publicly available information to determine which potential investments genuinely live up to their ESG promises. To cut through the noise, investors looking to prioritize ESG factors in their investment portfolios should make an effort to work with financial advisors with experience in ESG investing.
Why Choose ESG Investments?
In addition to their social benefits, ESG investments tend to be rewarding investments. Perhaps unsurprisingly, well-managed companies that maintain good environmental and human rights practices tend to be the ones that perform the best over time. A 2019 white paper produced by the Morgan Stanley Institute For Sustainable Investing compared the performance of ESG funds against the performance of traditional funds between 2004 and 2018, finding that the ESG investments provided a similar rate of return with a significantly lower level of downside risk.
Notably, during periods of high volatility, ESG investments tend to remain more stable and provide higher returns for investors. This risk mitigation can make ESG investments particularly attractive in an uncertain world, even to investors who are not focused on corporate social responsibility. Given all of this, it is perhaps not surprising that interest in ESG investments continues to grow. According to the US SIF’s 2020 Trends Report, investment in ESG investments grew by 42% between 2018 and 2020, accounting for some $17 trillion in professionally managed assets. This trend is unlikely to change anytime soon as investors continue to look for ways to mitigate the uncertainty and volatility associated with traditional investments.
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