What Are ESG Principles? Key Factors for ESG Investing

Today’s younger and more socially and environmentally conscious investors haven’t completely changed — like those who came before them, they still want to commit only to companies that are going to offer them healthy financial returns in the future.

That old financial bottom line is no longer all they care about, though. Modern investors want to put their weight behind companies that share their values, and which will make a positive change in the world.

To be able to assess how committed a given commercial venture is to corporate social responsibility policies and practices, the investors of the 21st century aren’t satisfied with token social programs or vague answers about planned environmental changes, either. Instead, they want to be able to measure the results of companies they are considering investing in concrete ways.

To do this, they often look at the key environmental, social, and governance (ESG) principles as they decide where they feel comfortable investing. ESG-based investments are currently believed to have passed the $20 trillion (!!!) mark, so being a good corporate citizen is about more than “just” doing good in the world today. It’s also an excellent business.

What Are ESG Principles?

ESG principles — in which the all-important three letters stand for “environmental”, “social”, and “governance” — are, at their very core, a set of guidelines that anyone with any stake at all in a particular company can use to assess how well that business is performing in terms of corporate social responsibility.

Together, these guidelines cover all the most important areas in which a company can contribute to the wider world, positively or negatively, and hold itself accountable to all stakeholders.

Companies can use ESG principles as a framework that enables them to work toward better corporate citizenship practices that improve the world around them. This is usually a complex and well-thought-out process during which a corporate responsibility or corporate sustainability team carefully analyzes what aims a business should have, as well as how to implement the company’s overall goals.

Consumers and investors alike can, on the other hand, use a company’s commitment to these principles as a guide in deciding whether they would be on board with doing business with that particular company.

As more and more investors place a strong emphasis on wanting to invest only in businesses that share their personal values and their vision for creating a better world, tools are also being put in place to help them on this quest.

Brokerage firms, mutual funds, and robo-advisors are all beginning to offer services that help potential investors determine how well companies are scoring in terms of ESG principles for responsible investment.

So, how are socially and environmentally aware, who are committed to leaving the world a better place than they found it (or at least than it’s currently in) “vetting” businesses they are considering investing in? Here’s a look at the parameters that may be considered in the process:

Environmental impact

Today, more than ever before, it has become abundantly clear that we all need to make radical changes to mitigate climate change. Serious ESG investors will want to assess how well companies they are thinking about investing in are performing in this area in a great amount of detail. They want to see results, not half-hearted commitments to changing course and adopting greener practices at some point in the future.

The company’s overall carbon footprint will fall under scrutiny in the process, and that includes looking at the impact the business currently has on the environment in terms of air quality, pollution, overall energy usage, and manufacturing methods, moves toward more sustainable energy, and active mitigation steps.

Social impact

Any effect a company has on the people and communities it interacts with in any way at all falls under this heading, so assessing the social impact a business has is just as complicated as looking at its environmental sustainability or lack thereof.

A common focus for ESG investors right now would lie in the company’s own workforce, which would include hiring practices, career progression, healthcare provision, and flexible working hours for employees.

Increased diversity is an important goal in today’s increasingly inclusive environment, and typical ESG investors will look at gender and racial equity parameters as well as how well a business does in terms of embracing members of the LGBTQIA+ community and people with disabilities.

The wider the scope of the company, the more factors need to be considered under this social impact heading — such as how wastewater practices are impacting local communities or whether all suppliers have ethical work practices. Customer satisfaction can also fall under this category.

Corporate Governance

This ESG criterion looks at the company’s leadership principles and leadership style. Modern ESG investors want businesses to be transparent from top to bottom, including in terms of shareholder voting rights and accounting transparency as well as opportunities for the workforce to offer feedback, and they tend to frown on most traditional types of political lobbying. They want to see open communication and channels of feedback and change between stakeholders and leadership.

See Related: ESG Key Performance Indicators to Follow

How does ESG investing work?

The ESG investing approach is designed to provide investors with the opportunity to make a positive impact on society and the environment. It seeks to invest resources in firms that receive high ratings on their environmental, social, and governance activities from third-party research groups.

These ESG ratings are based on factors such as a company’s carbon emissions, labor practices, corporate governance structures, and commitment to stakeholder interests. Investing through this approach can also provide financial benefits by reducing risk exposure or offering access to potentially uncorrelated returns.

Furthermore, it reduces the potential of investing in companies with poor ESG performance which could lead to potential reputational damage. Ultimately, ESG investing offers a meaningful way for investors to contribute towards creating a more sustainable world while still achieving financial objectives.

How do environmental, social, and governance (ESG) factors work?

Environmental, Social, and Governance (ESG) factors are a set of standards for a company’s operations that aim to consider the impact of its business on the environment, society, and governance.

The criteria are used to assess how well companies manage their social and environmental impacts as well as their corporate governance practices. This means that companies must be transparent about their policies and processes related to the environment, social issues, and corporate governance in order to meet ESG criteria.

For example, a company must demonstrate how it is reducing its carbon footprint or developing responsible labor practices. Companies should also show they have good internal processes in place to manage potential risks and conflicts of interest within the boardroom.

By incorporating ESG criteria into business decisions, companies can contribute positively to sustainable development while also increasing their competitive advantage by improving investor confidence and employee engagement.

See Related: Cleveland-Cliffs Inc. ESG Profile (CLF): Is It Sustainable?

How are ESG scores calculated?

ESG scores are calculated to measure the environmental, social, and governance activities of a company. To calculate the ESG score of a company, data is collected from several sources such as publicly available information, interviews with experts and stakeholders, and surveys. The data collected is then used to analyze the company’s performance in each of the three areas of ESG: environment, social responsibility, and governance.

Each area is given a score based on its performance in terms of environmental policies, labor practices, corporate governance structure, and other criteria. The overall ESG score for a company is then obtained by combining the scores for each area. This allows both institutional investors and retail investors to make informed decisions about their investments by understanding how well companies perform in terms of sustainability and ethical practices.

What ESG Factors Should You Care About?

Businesses play an enormous, and inevitable, role in the society we live in — and as such, the investors that back them up do, too. The principles definition we looked at makes it clear that ESG, as a framework for business ethics, leaves no stone untouched. These guidelines examine how a business relates to every single aspect of the world, and how the fact that that business operates in that world changes the company, the planet, and wider society.

There is absolutely no doubt that when you look at the framework of ESG factors and corporate social responsibility (CSR) in general, there is going to be a lot of overlap between the “E”, the “S”, and the “G” in “ESG”. The way in which a company cares for, or fails to care for, its workers, its customers, its shareholders, and the local communities it may be impacting, easily spills over into the domain of environmental sustainability.

Just as polluting practices have the potential to negatively impact the health, well-being, and even educational opportunities of affected communities, for instance, they will also have damaging environmental results. In turn, as such practices are increasingly becoming legally regulated, the ability to perpetuate them without consequence will require heavy but covert political lobbying.

In other words, a business will tend to either be committed to all of the ESG factors as a whole, making steps toward progress whenever that is possible, or it will fail on all accounts. These principles do not exist in isolation, but rather intersect more clearly the closer you examine them.

Nonetheless, there is no question that there is space for companies as well as investors to emphasize some ESG factors more than others as they decide how to move forward.

See Related: Cigna Corporation ESG Profile (CI): Is It Sustainable?

How can you be sure that an ESG investment aligns with my personal values and beliefs?

That, ultimately, depends on you — meaning you as an individual investor or even consumer, or you as part of a company in the process of deciding how to move forward with corporate citizenship fit for the 21st century.

While socially responsible investing takes more of an approach to solely focusing on your own personal values, ESG investing takes more of a quantitative approach using key ESG criteria used in investment analysis to determine what kind of exposure you may have to environmental risks. It’s a blend of sustainable investing and socially responsible investing.

Some people deploying an ESG investing portfolio will care most about the environment. It is easy to argue that climate change mitigation efforts are the single most important question of our time.

Unless radical steps are taken to reduce and reverse greenhouse gas emissions and move to a more sustainable model of living and doing business, those who place a higher emphasis on the “environment” portion of ESG principles will say, neither the social nor the governance portions of the guideline will be able to have any importance at all.

Companies who are committed to climate change mitigation will certainly find investors to back them up, and the more radical the progress, the more likely they are to find partners on the journey. Likewise, investors who are committed to building a more sustainable future are going to be able to find the perfect companies to back up.

Some will care most about the pressing social issues of our time, believing that change starts with people. In improving living and working conditions for all communities a company touches, it can realize immediate and measurable improvements that matter right now.

Whether a company chooses to focus on flexible working hours for employees, takes a political stand by refusing to work with suppliers from countries well-known for hostile labor conditions, or embraces opportunities for disabled workers, it will gain a measurable reputation boost and attract investors. Investors who are committed to improved social conditions will find adequate partners, too.

The governance portion of ESG principles can be seen as lying at the heart of the other two, or even holding them both up — because, without transparency and accountability, nothing else is clear. ESG data can help encourage companies to make better decisions across the spectrum of environmental, social, and governance issues.

See Related: Merck & Co., Inc. ESG Profile (MRK): Is It Sustainable?

How to Integrate ESG Considerations Into Your Investment Practices

Companies discussing how to implement ESG principles and strive toward better corporate citizenship should know that, while being the change in the world that they want to see is certainly a powerful motivator behind adopting ESG principles, there are more selfish reasons to consider ESG too:

• ESG investment is on the rise, and companies that have implemented ESG principles and that embrace the role they play in society as corporate citizens, in general, make higher profits and attract more investors. Investors who are female, Millennial, or especially wealthy are more likely to commit to only making ESG investments.
• The social principles of ESG — or the “people” portion of the triple bottom line — are incredibly important to the overall success of a business. Adopting increasingly equitable leads to happier, healthier, more productive, and more creative employees who will stay with your company for a long time, to take it to new heights.
• Adopting ESG principles causes profits to rise rather than tank, in a win-win equation that benefits all of society. Not just investment managers.

Adopting ESG principles, considering ESG training and even ESG certification, and putting CSR teams in place can only, in today’s environment, help companies in their mission of serving their customers while attaining solid financial returns.

Investors and potential investors can be proud, too. There is no doubt that their commitment to ESG investment is fueling change within businesses across the world, even those who would not have considered implementing ESG principles without this very real pressure to change.

Commercial ventures, from the smallest ambitious startups to the most well-established industry giants, are now taking their corporate social responsibility commitments to the next level precisely because they know that, while the bottom line still matters a great deal, it cannot be the only factor that investors consider any longer.

As an investor, all ESG principles for responsible investment should be an important consideration for you in your investment process. That is true because carefully considering the impact a business has on the environment and the people within it, as well as how it relates to both, fuels positive change from within.

Financial pressure is one of the easiest ways to cause the world you are hoping to live in tomorrow to come about, and the most important principles for ESG investing offer you a path to get there.

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