Reading a collective culture can help us achieve our goals and be successful in various sectors of daily life, regardless of your job or status. Clear examples of Environmental, Social, and Governance (ESG) criteria which represent an approach to investing and establishing those goals involve identifying companies that have built sound environmental practices and a strong corporate environment that is responsible for the environment, along with ethical governance initiatives in their corporate policies and daily operations.
What are ESG Criteria?
ESG criteria allow investors to understand a company’s retention (or lack thereof) of ethical practices. The three components are defined as follows:
1. Environment: The company’s impact on the environment and its ability to mitigate various risks that may harm the environment. This can include the company’s carbon footprint as well as its record regarding energy efficiency, waste management, water conservation, and other natural resource management, and animal treatment.
2. Social factors: Evaluates the company’s relationships with other businesses, its position in the local community, its commitment to diversity and inclusion within its workforce and board, its charitable contributions, and whether it has employee policies that promote health and safety.
3. Corporate Governance: Evaluates the company’s internal processes such as transparent accounting practices, leadership compensation, board composition, and its relationship with employees and stakeholders. It may also include internal regulations designed to prevent conflicts of interest and unethical behavior.
How does ESG work?
Many companies measure their performance concerning their ESG metrics and disclose this in annual reports and other documents. The ESG performance of individual companies is also measured and reported by external service providers such as Morningstar, Bloomberg, and MSCI, in addition to the media. Investors can search for companies to find out their results regarding ESG criteria using websites like Sustainalytics, which is part of Morningstar, which provides ESG ratings for companies and compares them to others in the same industry. You can also search online for the company’s name with the phrase “ESG report.” However, you should remember that companies often report on themselves, so it is advisable to verify with a third party.
The Emergence of ESG
According to the Commonfund Institute, a company that manages assets for nonprofit organizations and public pension funds, responsible investing dates back to colonial times when some religious groups refused to invest their funds in the slave trade. However, socially responsible investing didn’t gain prominence until the mid-20th century, driven in the 1960s by opposition to the Vietnam War and the civil rights movement, and in the 1970s by increased environmental awareness and widespread opposition to apartheid in South Africa.
As interest in values-based investing grew, the models used to evaluate it changed. The emergence of ESG criteria over the past two decades has flipped the concept of socially responsible investing from one of excluding companies to one that includes companies that rank highly in ESG criteria.
According to George Badola, a principal and chief investment officer at Modura Wealth Management, “People have decided they prefer to include companies that have some aspects — good governance and inclusion and diversity and environmental traits — rather than simply excluding stocks known to be bad stocks” (tobacco, weapons, gambling, alcohol).
Types of ESG Criteria
ESG issues can be challenging to classify clearly, but the CFA Institute has effectively categorized them as follows:
– Environmental Issues
– Social Issues
– Governance Issues
Other Perceptions of Environmental, Social, and Governance (ESG) Criteria
An increasing number of individuals are seeking to align their investment approach with their values, using different terms to do so. Among the ESG criteria that overlap and intersect with other issues are the following:
–
CSR: Corporate Social Responsibility Investments
– SRI: Socially Responsible Investing
– Sustainable Investing
– Values-Based Investing
– Impact Investing
ESG vs. CSR
CSR and SRI are interchangeable terms that refer to vague standard areas and reporting on corporate practices that have a positive environmental and social impact. Investing in ESG standards is more associated with a comprehensive approach that assesses companies based on their positive actions across environmental, social, and governance metrics through more measurable benchmarks.
Also, measuring CSR is an internal function, while ESG is an external function. This means that CSR programs are proposed and implemented internally. People within the company measure the success of CSR programs and decide which programs should continue and which should be revised if they do not achieve the desired results.
In contrast, ESG is a measurement that external analysts can use to objectively compare ESG effectiveness across companies.
ESG Investment Performance
One of the most common challenges regarding the adoption of sustainable investment guidelines is whether they lead to lower returns than broader market indices or comparable investments. However, according to a study by Morningstar in 2019, “41 out of 56 Morningstar ESG indices outperformed their non-ESG equivalents (73%) since inception.” Padula states that “as ESG ETFs and index funds grow, cost barriers have decreased and the number of options has increased. Performance competes with each asset class they follow, and some achieve better returns.”
Source: https://www.thebalancemoney.com/what-are-environmental-social-and-governance-esg-criteria-5112974
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