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The basics of ESG

By James Hancock | 25 Nov, 2021

What is ESG?

ESG (or Environment, Social and Governance) is a framework which aims to complement the investment decision process by incorporating sustainability into one’s objectives, alongside financial returns of the investments. ESG investing integrates a more holistic approach by assessing the wider impact of set of criteria and themes focused on the environment, society and governance factors when reviewing company’s performance.

ESG aware investing applies the principle a company’s financial performance is linked to other external factors, which historically may have been difficult to quantify, but should be accounted for within the investment evaluation as financial and ESG factors aren’t mutually exclusive.

Factors

Under ESG there isn’t a homogenous policy across all firms, but the following factors will be considered based on the ESG strategy.

Environment – Focuses on climate and the impact a company has on the planet, where historically the environmental negative externalities have been overlooked when compared with financial returns. This factor explores the impact of topics like climate change, emissions and pollution, resource depletion and scarcity, and waste to list a few.

Social – Focuses on company’s impact on stakeholders and wider society. This factor includes issues such as diversity, human and labour rights, animal welfare, etc.

Governance – Focuses of the principles and practices of the organisation itself. Governance focuses on the management, shareholder rights, remuneration and considerations which are central to the future of the company’s long-term future.

Methods of ESG Investing

The two main methods of investing in an ESG manner are Integration and Negative Screening; both add an additional layer to the existing investment strategy rather than being the exclusive investment approach.

Integration is the inclusion of ESG analysis and data into the overall investment decision-making process and strategy. This approach is popular among investment firms, and most will have their own scoring methodology used to assess each factor. Each ESG scoring methodology is likely to yield differing results based on the inputs.

Negative Screening is a method which directly excludes investments in companies or whole industries in line with the investors ethics, via hard rules which prohibit these holdings from the portfolio. Negative Screening is an additional layer to integration and can be built up over time with the client to address their preferences as they change over time.

What’s the difference between ESG, socially responsible, or impact investing?

In today’s media lots of different buzzwords are commonly thrown about surrounding this topic, with Socially Responsible Investing and Impact Investing often used interchangeably.

Socially Responsible Investing (SRI) differs from ESG as it is more client centric to the individual investor with a larger focus on their values. SRI is an investing framework in companies which are aligned with your morals, and often involves ethical screening and hard rules set to eliminate investments in industries, like tobacco, arms, etc.

Impact Investing is a form of investment where the intention is the generation of positive environmental and/or social impact via a direct investment, with less focus on financial returns.

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