Environmental, Social, Governance (ESG) criteria has grown in popularity as it serves as a strategy for investors to evaluate the potential companies they want to back. But what exactly is ESG criteria and ESG investing? This set of standards guides investors to invest in companies that “score highly on environmental and societal responsibility scales,” according to Forbes. In consideration of ESG factors, investors garner a more holistic view of the companies they are to support. ESG criteria cover the following factors:
- Environment. This factor looks at the environmental impact of a company. A company’s carbon footprint, toxic chemicals used in its manufacturing processes, and sustainability efforts throughout its supply chain are all taken into consideration.
- Social. This element evaluates a company’s improvement of social impact both in the local and broader community. Social factors include but are not limited to racial diversity, both in upper management and regular staff, LGBTQ equality, and inclusion strategies in hiring practices. This field additionally looks at a company’s advocacy for social good in a broader sense, beyond the limited business sphere.
- Governance. This standard covers ways a company’s board and management drive positive change. It includes everything from executive pay issues to diversity in leadership.
Although third-party rating firms rely on varying criteria when evaluating individual ESG components, commonly reviewed materials include annual reports, corporate sustainability measures, resource/employee/financial management, board structure, and compensation. Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv are listed as some of the most reputable ESG research firms. Generally, on a 100-point scale, the higher the score, the better a company does in fulfilling various ESG criteria.
One might ask “Why does ESG investing matter at all?” One reason to pursue ESG investing is that it is a way for investors to ensure that their investments align with their priorities. Aside from aiding in the fight against grave issues such as climate change and social injustice, an ESG investing strategy can offer higher returns as well. According to the Harvard Business Review, “More generally, a growing number of studies prove the payoff from focusing on long-term value and ESG.”Investment firms have gained increasing traction when evaluating companies’ performance in light of ESG practices. While ESG metrics are not commonly included in mandatory financial reporting, companies are increasingly disclosing them in their annual reports.
By Ani Bayramyan