ESG Investing - Definition, Explained, Examples, Types, What is it? (2024)

What Is ESG Investing?

ESG investing refers to a method that investors adopt to build investment portfolios based on environment, social, and governance (ESG) as criteria and gain financial returns while positively contributing to the society. In addition, it aims to measure businesses' sustainability by assigning ESG scores to them.

ESG investing criteria prevent investors from investing in risky and loss-making companies. Investors can invest in ESG through stocks and funds. First, the ESG scores are used to rank the stocks of a company according to their performance. Then, investors use the scores to invest in companies that align with their beliefs

• ESGinvesting refers to investing by an investor in a company based on its contribution to improving the environment, society, and governance.
• ESG score measures a company’s commitment to environmental, social, and governance improvement.
• It is a safe and high-return investment for the investor and the company as it helps them secure funds and sustainability in their business.
• Investors can invest in it by way of ESG stocks and funds.

ESG Investing Explained

ESG investing, also known as socially responsible investing, is a type of investment that investors use to prioritize buying shares in companies that care for the environment, social upliftment, and good governance. In other words, investors like to invest in stocks of companies that positively affect the three listed components.

It simply means that investors are increasingly using a set of common criteria for selecting companies that follow ESG standards. They determine the criteria the United Nations global compact or UN Principles for Responsible Investing and the Sustainability Accounting and Standards Board agree upon.

Many investors use the ESG standards while investing in funds because of the following:

1. Feel it is in line with their ideology of a free and fair world;
2. They observe that as per the latest ESG investing trends, they get better yield;
3. The ESG investing companies are more caring towards nature, people, and society;
4. The ESG investing funds discourage the companies from investing in harmful businesses like war, pollution, and sex discrimination.

ESG Scores

Investors can invest in ESG through stocks or funds. However, no mandate exists to show these for the companies on their financial reports. So, certain third parties assign ESG scores to companies and their stocks. Examples include Dow Jones Sustainability Index, Bloomberg ESG Data Services, Thomson Reuters ESG Research Data, and others.

The ESG scores measure companies' efforts in reducing carbon footprints, greener technology usage, community development projects, tax abiding, and avoiding legal issues. An investor can get the score from any third-party rating agency as a certificate in ESG investing. The investor then decides based on the following scores:

• Excellent ESG Score - Companies strictly follow ESG norms and positively impact the environment, society, and its governance.
• Good ESG Score - Companies follow ESG norms and have limited positive impacts on the environment, society, and its governance.
• Average ESG Score - Companies cannot meet ESG norms. They have zero or no positive impacts on the environment, society, and governance.
• Poor ESG Score - Companies do not follow any ESG norms and negatively impact the environment, society, and its governance.

The mutual fund houses also club the securities of various companies in various ranks according to the score that helps the investor to decide on investment. Thus, investors can choose the best company based on the score. After that, invest accordingly for reduced risk and high returns in the long term.

Types Of ESG Investing

Although there is a variety of ESG investing options available to investors, the prominent ones are the following –

#1 - ESG Stocks

Those companies which follow the ESG norms publish impact reports on their sustainable business practices accompanied by environmental initiatives and work related to social causes on their websites. Hence, investors may directly invest in these companies' stock without the need to invest in mutual funds containing a bucket of such companies.

#2 - ESG Mutual Funds

Currently, many mutual fund companies offer various portfolios of ESG to their investors. Often, mutual fund brokers offer investors a screening tool for deciding on the best-rated ESG funds in their offerings. So, investors find it easy to invest in such funds.

Examples

Let us look at some ESG investing examples in understanding this topic better.

Example #1

One can understand it by using Amacon Inc.'s example that the average ESG rating of Amacon is BBB. It means that Amacon is a leader in corporate governance, privacy of information, and data security. Still, its carbon footprint average, its labor-management is poor for it uses child and forced labor, and has bad corporate behavior.

Thus, any investor having ESG investing in mind will immediately look at Amacon's ESG record and find that it has been held guilty of price-fixing of books, poor treatment of workers, improper behavior towards pregnant lady staff, and unhealthy hazardous working conditions.

Hence, the investor may not invest much in such a company if s/he finds that it is not in compliance with its beliefs and ideology.

Example #2

An investor looking at the ESG report of Apple Inc. has a BB rating as per Morgan Stanley Capital International, a provider of stock index. As per the report, an investor can deduce that Apple accounts for the following:

1. Has followed ESG norms meticulously.
2. It has reduced negative impacts on nature to a great extent.
3. It has a well-developed sustainable business in place.
4. Its stocks have given positive returns to the investor

Hence, the investor will find Apple Inc. to be an attractive Investing in ESG stock or as a holding in an ESG portfolio stock.

Benefits

The observance of ESG while investing for investors and companies goes well beyond ideology, appeasing people, and creating a good public image. Hence, it is necessary to look at the important benefits of investing. They are the following -

1. Investing in ESG is a responsible investment that reduces the investment risk by removing the risky loss-making companies from the investors' portfolios.
2. Since companies adhering to ESG norms are cost-effective and do not incur advertising expenditures, the fees of investing in their securities are minimal.
3. As ESG-abiding companies have less expenditure and are cost-effective, they give better returns to their investors.
4. Investors get high performance and high yield in their ESG funds as they have those companies in their portfolio that have better governance, better reputation, undertake community upliftment activities, and have better profits than their peers.
5. It has numerous environmental and multiple social benefits like water conservation, pollution-reducing child labor control, sex discrimination, reducing afforestation, and committing to providing clean drinking water to the poorest sections of society.
6. In terms of governance, Investing in ESG motivates companies to be more efficient and economical by being forced to operate their business sustainably.

Frequently Asked Questions (FAQs)

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This article has been a guide to What is ESG Investing and its meaning. Here, we explain ESG scores, strategy, types, benefits, and examples. You can learn more from the following articles -

• Impact Investing
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