Environmental, social, and governance (ESG) are on the lips of everyone these days. So what is ESG investing, then?
‘Sustainable investment’ is an investment that contributes to environmental or social objectives. Firstly, sustainability is often defined as ensuring that development meets the needs of the present without compromising the capabilities of future generations.
Second, the investment shouldn’t hurt the goals of these activities, and the companies that get the money should use good governance practises. These investments are techniques for considering ESG factors in portfolio selection and management across seven sustainable or responsible investment strategies.
With that, ESG analysis has become an increasingly essential investment process. ESG investing is a good way for people to ensure their money choices match their values. One of the most popular investment vehicles is exchange-traded funds (ETFs), a pooled investment security.
Read: All You Need To Know About ESG And ESG Benefits
What Is ESG Investing: ESG ETFs
ESG ETFs make sustainable investing easy for investors. Moreover, ETFs offer low expense ratios and fewer broker commissions than buying stocks individually. ESG ETFs combine two investment strategies.
Firstly, ESG investing, or responsible investment describes various ways to incorporate ESG factors into the investment process. For investors, it is about investing in progress which helps companies perform better and create more value.
Secondly, ETF investing, in which ETFs invest in a basket of stocks, bonds, or other assets. In many cases, ETFs offer a flexible and low-cost way to build a highly diversified investment portfolio. So, ESG ETFs make it easy to spread your money out over a wide range of investments while still owning companies with strong ESG traits.
Read: How Technology And ESG Making The World A Better Place
What Is ESG Investing: The Various Types Of ESG Investing
Sustainable investing is a growing trend that combines traditional investment strategies with ESG considerations. Demographic shifts, trends, government policies, and evolving views on risk drive demand.
Sustainable investing has grown by leaps and bounds in recent years, where a recent survey found that 75% of respondents have integrated ESG into their investment approach. In sustainable investing, budgets are mandated
towards companies with business practices capable of being continued indefinitely without driving harm to current or future generations or exhausting natural resources.
The common problem is that companies may send their production to other countries or companies that don’t do much to ensure they are sustainable. A company might not look too deeply into its suppliers’ practises.
Best practises, on the other hand, would require companies to look at their resource chains and keep track of their production processes, from where the materials come from to how they are thrown away after use. Externalising costs also apply to forcing labour to subsidise activities, saving money with potentially health-damaging practices or insufficient wages.
Read: ESG Investing – How To Integrate It Into Your Investment Planning?
What Is ESG Investing: Sustainable Finance Disclosure Regulation (SFDR)
Responsible investors want capital to be used responsibly while providing a reasonable return and benefiting others. The Sustainable Finance Disclosure Regulation (SFDR) is the central pillar of the Sustainable Finance Action Plan. SFDR marks a big step for ESG investing as the EU seeks to enforce and align sustainability requirements.
Although non-EU companies are not legally obligated to disclose sustainability-related data, this shift in the industry could also impact the United States markets and set the standard for the future. SFDR aims to ensure that EU investors have the disclosures to make investment choices that align with their sustainability goals.
Nonetheless, significant challenges require collective solutions that need a shared purpose and practical assessment of risks. Other than that, people need to change from a market society to a market economy, where the values can be reassessed within the transition process.’
Read: ESG Investing And The 3 Steps To Build An ESG Portfolio
What Is ESG Investing: Getting To Know The ESG Indices
With impact investing, Morgan Stanley Capital International (MSCI) measured the alignment of 8,550 companies in the MSCI All Country World Index (ACWI) to the United Nations Sustainable Development Goals (UN SDGs). An investable framework is mapped to the UN SDGs with nine pillars:
- Circular economy;
- Sustainable energy;
- Food & Agriculture;
- Water & Sanitation;
- Health & Social care;
- Financial inclusion;
- Sustainable real estate & Infrastructure;
- Education & Employment, and;
- Impact leader.
The three stages of impact are measured against intentionality, implementation, and impact. Firstly, intentionality is when companies must clearly define a strategy (qualitative) supported by a significant R&D budget (quantitative).
Second, implementation checks how well a company’s strategy and R&D work are working to meet a certain revenue threshold and growth goals for each pillar. Lastly, a company with an impact strategy tells the public about specific pillar indicators and shows yearly progress.
Nevertheless, companies whose products and services do not fit within the pillars are integral to the supply chains and enable other pillars to contribute positively to society. There are two common approaches to screening: negative and positive screenings.
What Is ESG Investing: Negative Screening And Positive Screening
Negative screening excludes companies producing ‘undesirable’ products such as alcohol, tobacco, gambling, adult entertainment, and weapons manufacturing. The main challenge is deciding whether a company should be excluded if only part of its operations is involved in an ‘undesirable’ activity.
To address this, the accepted exposure level to that activity may be used to determine the firm’s turnover or revenue: the lower the level, the stronger the exclusion.
In contrast, positive screening supports companies that provide positive solutions to challenges such as climate change and social justice. This excludes companies concerned with activities considered to be unacceptable. Green bonds were created to fund projects that have positive environmental benefits.
Read: The Islamic Sustainability Approach In ESG
What Is ESG Investing: Types Of ESG approaches
Green bonds are traditional debt instruments where the funds raised are used solely to finance or refinance, in part or in full, new or existing eligible ‘green’ projects with positive environmental or climate advantages. These include energy efficiency, pollution prevention, sustainable agriculture, clean transportation, and environmentally friendly technologies.
However, green bonds lack standardisation as to what comprises a green bond in the first place. The simultaneous concern is that it could become a convenient label for marketing objectives.
The Green Bond Principles (GBP) were made by the International Capital Market Association (ICMA) to deal with this problem. These rules suggest openness and transparency and encourage honesty in building the green bond market by laying out the essential parts of a credible green bond.
What Is ESG Investing?
So what is ESG investing? In summary, ESG investing or ‘sustainable investment’ is an investment that contributes to environmental or social objectives.
About the Author
Mukhriz Mangsor is currently the Head Global Market Strategist at Quantdynamic Research Company. His areas of expertise include financial education, financial institutions, and property trading with clients, including firms in Brunei, Canada, Malaysia, Singapore, and the United States.
