ESG Definition, Principles And Examples

What is ESG? What is the definition of ESG sustainable investing? Is it the same as CSR? About are governance, social and environment factors all about? What Is the difference between ESG, SRI, and impact investing? We’ve carefully gathered all the relevant info on these questions for you. Let’s find out.

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What Is ESG Investing? A Simple ESG Definition

The financial times lexicon defines ESG as a concept universally used by investors in capital markets to assess corporate behavior and to evaluate the future financial performance of corporations by measuring their sustainability.

ESG Definition: Sustainable Investing Funds

According to Robeco, an asset management firm, ESG uses Environmental, Social and Governance factors to evaluate companies and countries on how far advanced there are with sustainability. The firm also says that once enough information on these 3 criteria has been delivered, they can be combined with an investment process to help decide which equities or bonds are best to buy.

Ultimately, ESG is a term that encompasses investments that aim to have positive returns and a long-term impact on people, planet and the on business performance. As it identifies investments’ potential risks and opportunities beyond technical valuations, ESG has the potential to enhance the traditional financial analysis mostly because these companies are more likely to outperform in the long-run when compared to the competition.

ESG Definition And CSR Definition: What’s The Difference?

The CSR definition represents all of the practices companies develop to support the principles of sustainable development. It is about integrating social and ecological concerns into business activities and adopting a long term vision as opposed to short-term value.

According to the European Federation of Financial Analysts Societies (EFFAS), “ESG is a generic term used in capital markets. Often, it is erroneously equated with terms like Corporate Responsibility or Sustainability. However, when mainstream capital markets look at ESG, two focal points immediately emerge: risk caused by (bad) ESG performance and business opportunities based on proactive ESG performance. Corporate Responsibility reports from corporates address several stakeholder groups, not just investors and financial analysts.”

So we can tell that ESG and CSR not only care about profits, finances, and governance but also consider people and the planet, clearly contributing to sustainability and sustainable development. While CSR strongly focuses on engaging stakeholders, ESG is more about capital markets where investors choose businesses that disclose information on their ESG strategies.

ESG Factors In Sustainable Investment Funds

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Responsible investors assess corporations using ESG criteria as a framework to screen investments or assess risks in investment decision-making. Let’s find specific examples of how companies can act on the 3 ESG factors – environmental, social and governance.

ESG Sustainable Investing: Environmental Factors

Environmental factors are about a company’s impact on the environment. They are based on the premise that business activities have the potential to create environmental risks for ecosystems, water, air and human health. Examples of companies’ ESG factors can be the following:

  • Using energy efficiently;
  • Using renewable energies that emit fewer GHG, are less polluting, and contribute less to climate change;
  • Managing waste responsibly (like adopting circular economy principles);
  • Having responsible practices across the value chain such as no deforestation policies or even animal welfare;
  • Disclosing information on all environmental policies.

As a result, positive outcomes such as decreasing costs and improving profitability due to better energy efficiency are expected. Reputational risks will also reduce.

ESG Sustainable Investing: Social Factor

Social factors have to do with the way businesses treat and value people. In other words, it is about the impact that companies can have on their employees and on society. What do these companies do exactly?

  • Diversity and inclusion policies to ensure no type of discrimination;
  • Safe and healthy working conditions for employees;
  • Labor standards across supply chains that guarantee fair wages and human rights protection;
  • Good relations with local communities who give social license for companies to operate;
  • Companies also need to report information on what they’re doing on this area.

As a consequence, business productivity and employees’ morale increases, turnover decreases, and reputational risks are better managed. It also gets easier to work without social pressure from stakeholders, as there’s social license to operate.

ESG Sustainable Investing: Governance Factor

Governance factors focus on corporate policies and how companies are governed. It is about making the responsibilities, rights, and expectations of stakeholders clear so that interests are met and a consensus on a company’s long-term strategy is achieved. Examples of specific factors under which governance is analyzed can be:

  • Tax strategy;
  • Corporate risk management;
  • Executive compensation;
  • Donations and political lobbying;
  • Corruption and bribery;
  • Board structure and brand independence;
  • Protecting shareholder interests;
  • Disclosing information on these topics.

The effects of these policies can go from aligning shareholders’ interests with management to avoiding unpleasant financial surprises and having a better social acceptance as a result of wealth being fairly distributed.

How To Invest In ESG Sustainable Funds

ADDEC Innovation cites Gitterman Wealth Management, a financial advisory firm that gives a very clear point of view on how ESG works effectively. According to them, a successful ESG investor adopts the following strategy: “First, he will identify a set of compelling investments, based on his traditional investment selection criteria. Subsequent to doing so, he will apply an ESG lens to this set of viable investments. Last, but not least, he selects those investments that are anticipated to generate a scalable, profitable impact”. 

How To Report ESG Factors

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The European Federation of Financial Analysts Societies (EFFAS) says companies should point out how ESG is important for their businesses and share how they integrate ESG factors within their ESG strategy. They suggest that organizations develop and disclose their strategy to enhance transparency about risk exposure.

In other words, the EFFAS invites companies to determine and communicate the current and future relevance of ESG topics. They advise presenting ESG data in the company’s annual report, on the corporate website and in meetings with investors.

But what data should be communicated? Well, the EFFAS defined nine areas to help assess a company’s ESG performance. Along with these main topics that cover all industries and sectors, they’ve also identified specific key performance indicators (KPIs):

  • (Environmental)
    • Energy efficiency (KPI Ex: energy consumption per unit of production value)
    • GHG emissions (KPI Ex: GHG emission per employee)
  • (Social)
    • Staff turnover (KPI Ex: percentage of employees leaving per total full-time employees)
    • Training and qualification (KPI Ex: average expenses on training per employee)
    • Maturity of the workforce (KPI Ex: percentage of the workforce to retire in the next 5 years)
    • Absenteeism rate (KPI Ex: number of man-days lost per employee)
  • (Governance)
    • Litigation risks (KPI Ex: number of lawsuits related to anti-competitive behavior)
    • Corruption (KPI Ex: percentage of revenues in regions with TI corruption index below 6.0)
  • (Long-term viability)
    • Revenues from new products (KPI Ex: percentage of revenues from products at end of life-cycle)

If you’re looking to start disclosing ESG information, apart from the EFFAS report, take a look at the London Stock Group Exchange report. They offer plenty of great tips, best practices, and trends on how to make a good ESG report.

ESG, SRI And Sustainable Investing

Environmental, social and governance (ESG), socially responsible investing (SRI) and impact investing are several categories of sustainable investing. Although these terms are often used as if they mean the same, there are differences between them.

SRI, for instance, stands for socially responsible investing. Although it stands for sustainable investments too, SRI can be considered the next stage of ESG for investors who want to invest in specific companies. According to Mark Cussen, contributor for Investopedia, SRI eliminates or selects investments according to specific ethical guidelines such as religion, political beliefs or personal values. This way, SRI uses ESG factors to negatively screen investments on the gambling or weapon industry. From another perspective, SRI can also help to positively screen companies that contribute to scientific investigations or that supports charity associations.

Finally, there is impact investing. Impact investing is a type of investment where positive impacts are the most important. This means investors believe in the core business or the ultimate mission of an organization and are willing to financially bet on them. The ultimate goal of these investments is to create a positive impact on society or the environment- they are willing to risk the return of their investment in doing so. For instance, investing in a non-profit that’s researching how to cure cancer, helping associations fight inequality, or developing renewable energy and water purification systems in poor companies can be considered impact investing.

 

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