We all see the world in our own way. Our friends, our community, our government, and our environment reflect the collective values of people as we interact with. These values are established indirectly through elected representatives. Viewing societies worldwide shows that there is a wide range of acceptance for the appropriate level of profits, executive salaries, worker salaries and environmental care. As investors, we typically measure our results by looking at the dividends we earn and the growth in our stock value. These indicators are quite easy to quantify so we can compare and analyze these decisions. But should there be other concerns that you consider as well? I want to go over today why you should consider Adding ESG to investment decisions you make going forward.
Why should we be concerned with Ethical Investing?
Investors are ultimately driven to invest by the expectation of company revenue and how companies decide to use it. This is done either through distributing profits to shareholders through dividends or by reinvesting. Companies are only rewarded with profits when they are able to meet the demand of the consumer.
Most countries recognize that markets are rarely perfect. However, there are certain situations in which the government can play a role in ensuring the best possible outcome for an economy. These include regulating anti-trust issues, worker health and safety, and water and air standards. If the government were fully successful in addressing these issues and consumers had perfect information on a firm’s behavior, investors could simply turn a blind eye to how companies treat people or the environment.
Before making an investment, it is important to take into account three concerns. First, create a set of requirements other than profit that is important to you and your family. Second, create a set of performance measures that the company should sustain, that should be held in lower importance than the ethical requirements. Finally, create a set of actions that are determined beforehand that should be carried out if the company fails to perform in either of the other categories.
What is ESG?
Environmental, social, and governance (ESG) criteria are a set of standards for a company’s behavior used by socially conscious investors to screen potential investments. ESG criteria include environmental measures such as corporate policies addressing climate change. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
- Environmental – Environmental criteria may include corporate climate policies, energy use, waste materials, pollution and natural resource conservation. The criteria can also help evaluate any environmental risks a company might face, and how the company is managing those risks. Considerations may include direct and indirect greenhouse gas emissions, management of toxic waste material, and compliance with environmental regulations.
- Social – Ethical, social and environmental criteria look at the company’s relationships with stakeholders. For example, does it hold suppliers to its own ESG standards? Or does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do workplace conditions reflect high regard for employees’ health and safety?
- Governance – governance standards ensure that companies use accurate and transparent accounting methods, pursue integrity and diversity in their leadership selection process, and are accountable to shareholders.
How to Identify appropriate ESG concerns?
Socially responsible investing allows investors to conduct positive and negative screens on companies they believe are engaged in sustainable practices. These investors primarily value their non-financial values, such as environmental stewardship, consumer protection, human rights, and racial and gender diversity. They actively avoid investing in companies or organizations whose businesses run counter to their non-financial values and ethical principles or those they perceive to have negative effects on society; including businesses across the alcohol, tobacco, fast food, gambling, weapons, fossil fuel, or defense industries.
While both socially responsible investing (SRI) and environmental, social, and governance (ESG) investing are a testament to the ways sustainable practices can be incorporated into decision-making and investment strategy, ESG is the contemporary choice for investors concerned about long-term growth. Those who take the ESG route are equipped with metrics that quantify financial risk and opportunity, while SRI investors engage in decision making primarily on principle. To facilitate long-term growth, it is imperative to analyze companies’ ESG performance and examine how activity in the markets influences the world in which we live.
What are the main Criticisms of ESG, and should you add ESG to Investment Decisions?
Ethical investing has been called into question by some investors, who argue that it doesn’t further the aims of environmental or social justice. However, demand for ethical investing is expected to increase as more progressive millennials and Gen Zers start to inherit money from their conservative parents.
If the SEC fails to release adequate rules on ESG, we should expect to see an ever-increasing appetite for alternate investment approaches. Even if the final SEC rules are strong, ESG can never completely starve industries like fossil fuels. As companies and funds dump their coal mines to bump up their ESG scores, for example, those mines just get bought up by private equity firms, resulting in money moving around but no fundamental changes. Consider: More than one third of all assets under management are now in socially responsible or ESG funds, yet global emissions continue to increase.
