Everything You Should Know About ESG Investing and Its Types
You can adopt an environmental, social, and governance (ESG) investment strategy to invest in businesses that work towards making the world a better place to live. Investors, as responsible citizens, are increasingly aware of how decisions businesses today make have an impact on the environment and society.
ESG investing counts on unbiased assessments and ratings that enable investors to evaluate a company’s policies and practices with regard to economic performance owing to its environmental, social, and governance performance. Businesses are under increased pressure to address growing global concerns when social and environmental problems become very serious. A company’s business operations and values are just as important as its financial performance.
Sustainable investors prioritise bringing about constructive social change when making investment decisions, and as a result, they take companies’ ethical principles into consideration when making investments in addition to financial gains. Among different types of ESG investing, you can invest in ESG stocks and mutual funds.
Know What ESG Investing Is
ESG investing, sometimes called sustainable investing or socially responsible investing, is a strategy used by investors to set a high priority on purchasing shares of businesses that support the environment, good corporate governance, and the advancement of society. To put it simply, investors prefer investing in the stocks of businesses that place an emphasis on the best non-financial aspects and how they positively influence the three elements viz. environment, social, and governance factors.
It implies that investors are imperceptibly choosing companies that adhere to ESG standards based on a set of established criteria. They choose the standards that the Sustainable Accounting and Standards Board and the UN Principles for Responsible Investing or UN Global Compact mutually agree on.
It means that businesses that have a negative or harmful effect on the environment or society, such as those who engage in child labour, violations of human rights, or gender inequality, are not considered. As a result, most investors, especially the institutional ones, compel businesses to bring positive changes by being environmentally and socially responsible.
ESG Factors to Consider for Investing
The ESG investment method involves investing in businesses that receive high scores from independent organizations, third parties, and research groups on their environmental and social responsibility measures. With ESG investing, it is presumed that a company’s performance will be influenced by a number of environmental, social, and corporate governance factors, such as the use of resources, biodiversity, resource use, resilience, business ethics, racial diversity, product governance, occupational safety and health, and human capital.
Investors considering ESG concerns receive a more comprehensive understanding of the businesses they support, which can help reduce risk and give opportunities. While assessing a company, some factors to take into account are:
- Environmental
Climate change, greenhouse gas emissions, biodiversity loss, deforestation, clean technology, resource depletion, water pollution, and waste management are some of the crucial environmental issues. How much do a company’s business operations impact the environment? It involves the carbon footprint, use of hazardous materials in manufacturing, how closely a company’s activities adhere to environmental rules, and how hazardous waste is disposed of.
- Social
When comes to social elements, they are related to an organisation’s business relationships, both internal and external. In what ways does a business bring positive social changes both within the organisation and the community? Some major social elements are human rights, working conditions, conducive labour policies, employee diversity, data security, equality, health and safety, child labour, and community standards.
- Governance
Governance factors are majorly associated with business ethics, structure, management, taxation, accounting regulations, bribery and corruption, and compliance. Some of the issues you may consider are – “Conflict of interest surrounding the appointment of directors or board members” and “the way shareholders and management interact”.
Smart ESG investing involves identifying and assessing the social impact the company has on its stakeholders, which include shareholders, customers, communities, employees, and the environment.
Some Types of ESG Investing
Among different ESG investing options, the distinguished ones are:
- ESG Stocks
Companies that comply with the ESG standards post impact reports on their websites along with information about their actions for environmental protection and work supporting social causes. It helps investors invest in such companies’ stock directly.
- ESG Mutual Funds
You can find several mutual fund providers, offering diverse portfolios of ESG to their customers. With a screening tool from mutual fund brokers, investors can determine the ESG funds showing the best ratings. This makes it easy for investors to invest in these funds.
Some Significant ESG Investing Strategies to Consider
You need to consider some prime strategies to build a portfolio using ESG factors. It is better to choose the criteria that very closely match your motivations, current processes, and goals because sustainable investing is still in its infancy and there are no official standards to integrate these elements when deciding to invest.
- Negative Screening
It is a process of eliminating particular industries or companies from a portfolio or fund. It is accomplished by ascertaining the exclusion criteria forthright to realise a particular objective. Negative screening is often referred to as exclusionary screening due to this.
For instance, you can take all fossil fuel businesses out of your portfolio if your objective is to lessen the effects of climate change.
- Positive Screening
The process of choosing a division of leading businesses from a specified industry, as well as the features to invest in, is known as positive screening. You can also call it the best-in-class screening.
It is the reverse of negative screening, for you need to decide in advance the performance metrics you will use to choose the best performers rather than setting requisites to avoid companies not meeting them. For instance, you could invest in textile companies that have a lower carbon footprint.
- ESG Integration
Businesses with a high level of sustainability and good ESG ratings are positioned as investment opportunities with the potential to boost a portfolio’s return using the ESG integration strategic lens. This approach incorporates ESG issues into an organization’s current investing process rather than setting a specific set of requirements, as with the screening processes. It is another factor to get returns.
The type of ESG investing plan you choose will depend on the ESG factors surrounding the structure, procedures, and ideals already in place at your company and your own motives.