ESG means using Environmental, Social and Governance factors to evaluate companies and countries on how far advanced they are with sustainability. Once enough data has been acquired on these three metrics, they can be integrated into the investment process when deciding what equities or bonds to buy.
ESG investing refers to a class of investing that is also known as “sustainable investing.” Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. ESG investing grew out of investment philosophies such as Socially Responsible Investing (SRI), but there are key differences. Earlier models typically use value judgments and negative screening to decide which companies to invest in. ESG investing and analysis, on the other hand, looks at finding value in companies—not simply at supporting a set of values. SRI uses exclusionary filters to keep companies out of portfolios that don't meet certain criteria, while ESG opts-in to companies that are making positive impacts in the three factor areas.
Following are examples of ESG issues.
Environmental risks created by business activities have an actual or potential negative impact on air, land, water, ecosystems and human health. Company environmental activities considered ESG factors include managing resources and preventing pollution, reducing emissions and climate impact, and executing environmental reporting or disclosure. Environmental positive outcomes include avoiding or minimizing environmental liabilities, lowering costs and increasing profitability through energy and other efficiencies, and reducing regulatory, litigation and reputational risk.
Social risks refer to the impact that companies can have on society. They are addressed by company social activities such as promoting health and safety, encouraging labor-management relations, protecting human rights and focusing on product integrity. Social positive outcomes include increasing productivity and morale, reducing turnover and absenteeism, and improving brand loyalty.
Governance risks concern the way companies are run. It addresses areas such as corporate brand independence and diversity, corporate risk management and excessive executive compensation, through company governance activities such as increasing diversity and accountability of the board, protecting shareholders and their rights and reporting and disclosing information. Governance positive outcomes include aligning interests of shareowners and management and avoiding unpleasant financial surprises.