If you were told that you could earn similar returns (or more) on your investments, and create a positive impact on our planet, would you believe it? Well, I have good news: it's possible, and one way to do it is by investing your capital sustainably. Today, ESG investments account for over $30 trillion USD (about 25%) of all assets under management (AUM), with the total number of sustainable investments projected to grow at a remarkable pace each year. But what is ESG investing?
What is Environmental, Social, and Governance (ESG) Investing?
According to Investopedia, ESG refers to the environmental, social, and governance factors of a company or an investment that may have a material impact on the performance of that investment.
ESG investment decisions are made by assessing a company’s environmental, social, and governance practices. Analysts can use this information to assign each company an ESG score, in which they can compare to other companies. According to Investopedia, responsible and forward-thinking organizations tend to receive higher ESG scores. For example, a company that proactively manages its carbon footprint and produces less waste tends to perform better in the environmental section of the ESG analysis and would receive a higher rating in this section.
A high scoring company may indicate that the firm is sustainable and has positive financial performance indicators for the future.
How does ESG investing work?
“For investment professionals, a key idea in the discussion of ESG issues is that systematically considering ESG issues will likely lead to more complete analyses and better-informed investment decisions” - CFA Institute (2015)
Simply put, an investor may integrate ESG factors to try and improve traditional financial analysis. They do this by identifying growth opportunities and potential material risks that traditional technical valuations don’t account for; thus, they may incur less risk and make more well-rounded investment decisions.
For example, ESG analysis could factor in the risk of an oil company causing a spill, and how that could impact their financial performance, while traditional measures usually focus more on analyzing a company's financial statements.
RBC's iShares ESG Equity ETFs is an example of existing ESG funds. According to RBC, these funds are built by screening out (or excluding) risky industries such as firearms, controversial weapons and tobacco industries and screening out securities with severe controversies. This is done to try and maximize the funds' ESG Score by minimizing risk while attempting to earn higher returns.
Is ESG investing a fad?
Climate change is seen to be a leading driver of ESG investments and a crisis that is not going away soon. Investors recognize this, and want to know that business leaders acknowledge and demonstrate their awareness of these issues.
The future of ESG investing
Sustainable investing is no longer a niche area, it’s going mainstream. More investors are taking a long-term approach and choosing to invest in companies that both aim to generate high returns and operate responsibly - the business case is strong, and the future of ESG investing appears to be bright.