How to Understand ESG Without Being an Expert

First of all, what does ESG stand for?

ESG stands for Environmental, Social, and Governance or (ESG).

Please explain?

ESG are three central factors in measuring the sustainability and ethical impact of a company. ESG factors, though non-financial, have a material impact on the long-term risk and return of investments. ESG is incorporated into risk mitigation, compliance and investment strategies. Companies that use ESG standards are more conscientious, less risky and are more likely to succeed in the long run.

Is this an Investment Strategy?

Yes, investors who employ this strategy examine criteria within these three categories to analyze stocks. Combining the ESG lens with more traditional stock analysis techniques is known as ESG integration. Anyone can join the swelling ranks of ESG investors by simply learning more and then using this framework in making future investing decisions.

It’s no wonder ESG investing is gaining traction. Research is increasingly showing that this investing method can reduce portfolio risk, generate competitive investment returns, and help investors feel good about the stocks, mutual funds or ETFs they own.

According to US SIF’s 2018 Report on Sustainable, Responsible, and Impact Investing Trends, total SRI assets jumped 38% to $12 trillion since 2016 in the U.S. alone. These assets represent 26% of the total U.S. assets under management ($1 in $4). For perspective, when US SIF first measured the size of the market in 1995, it was $639 billion; the area has increased 18-fold and has since enjoyed a compound annual growth rate of 13.6%.  This growth pattern will continue.

How Do They Work?

Environmental criteria consider how a company performs as a steward of nature.  Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. The criteria can also be used in evaluating any environmental risks a company might face and how the company is managing those risks. For example, are there issues related to its ownership of contaminated land, its disposal of hazardous waste, its management of toxic emissions, or its compliance with government environmental regulations?

Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. For instance, does it work with suppliers that hold the same values as it claims to hold? Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do the company’s working conditions show high regard for its employees’ health and safety? Are other stakeholders’ interests taken into account?

Governance criteria deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.  Also, investors may want to know that a company uses accurate and transparent accounting methods and that stockholders are given an opportunity to vote on important issues. They may also want assurances that companies avoid conflicts of interest in their choice of board members, don’t use political contributions to obtain unduly favorable treatment and, of course, don’t engage in illegal practices.

Many corporate governance details are found in the sustainability reports, but interested investors should also read the annual proxy statements they receive from companies they own shares of. To research corporate governance attributes (including interesting tidbits such as CEO pay) before buying a stock, you can access proxy statements on the SEC’s website by searching for the filing type DEF 14A.

Hopefully ESG investing has been somewhat demystified for you now — or, if you were already aware of it, perhaps your enthusiasm for the investing philosophy has been stoked further or renewed. If you’re attracted to socially responsible investing, and you want your portfolio to outperform the broader market, ESG investing could be a great match for you.

Future ESG articles will contain areas such as Investing in ESG, Risks and Returns.  Stay tuned.

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