ESG Investing – A Primer
An acronym for Environment, Social and Governance, ESG factors are a set of standards increasingly used by responsible investors to evaluate potential investments. These factors are not a part of traditional valuation or decision making processes but may still have financial relevance and are being incorporated by investors into their investment process.
Such investments seek to encourage responsible corporate practices by measuring the performance of the company not only on financial and market / industry parameters but also on the company’s performance on ESG related parameters. It is here that the concept of the triple bottom-line comes into play. It is the premise that a company’s performance cannot be measured on the basis of profits alone; the company’s social and environmental impact are also key to sustain long term growth.
ESG issues: Examples
ESG investing is often used interchangeably with impact investing, sustainable investing and responsible investing.
A little background
The Socially Responsible Investing movement, a precursor of ESG investing has been around for a much longer time in one form or another, where certain business activities as well as investments in such businesses were prohibited on moral or ethical grounds. This was more in the nature of exclusionary investing where companies whose operations can have negative social or environmental impact are excluded from the investment portfolio. For example barring slave trade or investments in companies producing guns or tobacco etc.
ESG investing assumes that ESG factors have a financial relevance and helps investors understand the long term risks and returns profile of a company. Therefore it is not only a moral or ethical question to invest in companies which perform well on ESG factors, but also one of financial prudence. This is more on the lines of inclusionary investing where companies whose operations can have a positive social or environmental impact are selected for the investment portfolio. For instance a fund may target to invest in companies that produce renewable energy or a company that builds affordable housing.
How it all began
In 2004, the then UN Secretary General Kofi Annan invited over 50 CEOs of major financial institutions to participate in a joint initiative to find ways to integrate ESG into capital markets in collaboration with the UN Global Compact, the International Finance Corporation (IFC) and the Swiss Government. In 2005, a report titled, ‘Who Cares Wins” by Ivo Knoepfel was published and it emphasized the benefits of incorporating ESG factors in capital markets for more sustainable markets and better outcomes for societies. Around the same time, the United Nations Environment Program Finance Initiative published a report that highlighted the relevance of ESG issues in financial valuation, that is, ESG factors can have an impact on a company’s financial performance.
Principles for Responsible Investing (PRI)
These two reports paved the way for the launch of the Principles for Responsible Investment (PRI) initiative – a network of international investors who developed a framework comprising six guiding principles for all investors to incorporate ESG issues into their decision processes. The process was convened by the United Nations Secretary-General.
There are six Principles of Responsible Investment that have been developed for implementation in view of the increasing relevance of environmental, social and governance issues to investment decisions.
- Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
- Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
- Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
- Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
- Principle 6: We will each report on our activities and progress towards implementing the Principles
The PRI has more than 2,300 signatories (2018-19)
The United Nations’ Sustainable Development Goals
In 2015, the United Nations listed 17 goals – the Sustainable Development Goals as a blueprint to achieve a better and more sustainable future for all to be achieved by 2030.
The 17 goals offer companies a framework towards creating a roadmap for sustainable growth, while taking into account all stakeholders.