ABC of ESG Investing

ESG simply stands for Enviromental, Social and Governance.

The importance of ESG analysis in the investment process is on the rise. Investors and fund managers across the globe are gaining a deeper understanding of the businesses they invest in by examining environmental, social, and governance (ESG) issues as part of their financial analyses. 

So what is ESG Investing? 

ESG simply stands for Enviromental, Social and Governance. Investors are increasingly applying non-financial factors in their screening process to understand the impact of ESG factors on their invested companies. Companies are also waking up to the need and importance of ESG responsibilities and are making disclosures in their annual reports and sustainability reports, only to show how their ESG responsibilities and their proper execution are gauged by the investment professionals. 

ESG criteria for the screening are interlinked are the same criteria/factor may overlap between Environmental, Social or Governance issues. 

Broadly speaking, climate change and carbon emissions, air and water pollution, biodiversity, deforestation, energy efficiency and the like qualify for environmental factors. Customer satisfaction, gender and diversity, employee engagement, human rights, and labour standards constitute the social responsibilities of companies. Board composition, Audit committee structure, executive compensation, and whistleblower schemes are some of the governance factors.

ESG investing has gained popularity with large institutional investors attaching significant importance to ESG scores of investible companies. 

However, it is at the same time the most misconstrued term in the world of investing as it is difficult to attach a monetary value to a company’s ESG score. Moreover, ESG ratings are built on comparative rankings of industry peers, not on universal standards. So if a company that performs badly on ESG score may still be able to get a good ESG score as its peers are worse off. Moreover, the relative score of a company might change void of any changes in that company level but simply because the peer average has changed.

“ESG ratings don’t measure a company’s impact on the Earth and society. In fact, they gauge the opposite: the potential impact of the world on the company and its shareholders,” states Bloomberg.