ESG FOR BEGINNERS

What is ESG?

Environmental, Social and Governance (ESG) investing has grown rapidly. Importantly, ESG is not one thing and so it can be confusing. That is why we wrote ESG for beginners. We will help you become an insider in no time.

 

ESG is a spectrum of options. It can mean excluding investments on moral grounds. It can mean reducing ESG risks to returns. And it can mean investing to make a positive impact on the world.

 

Before you embark on your ESG journey it is important to have clarity on your goals. Are you concerned about risks to your returns and/or impact of your investments? Are you willing to invest in any sector, or do you want to take some sectors off the table? Let’s dig a bit deeper to help you decide.

The ESG Spectrum

ESG Exclusions or "Negative Screening"

On the one end of the ESG spectrum, ESG investors exclude investments that are against their beliefs. This method is called “negative screening”. The oldest example is religious organizations that refuse to invest in vices such as gambling, weapons and alcohol. (You can read more about the history of ESG here.) Clearly, these days some ESG investors will not invest in fossil fuels and  some investors might divest from companies with major links to Russia.

ESG “Integration” ("Positive Screening")

Further along the spectrum, ESG investors want to “integrate” ESG into their investments.

 

These ESG investors do not take anything off the table. Rather, they do “positive screening” to include in their portfolios companies that manage ESG risks to returns well and/or that are improving their ESG impacts relative to their peers.

 

These investors want to reduce material ESG risks to their returns from problems such as climate change (E), pandemics (S) or corporate scandals (G). These days, there is a lot of attention on climate risks. There are two main types of climate risks that investors consider. 

 

Physical risks are posed by climate change itself, such as extreme weather events and natural disasters. Transition risks are posed by how we respond to climate change. For example, companies face risks from climate-related taxes and regulations and changes in consumer behavior.

 

Additionally, ESG integration may involve positive screening for companies with plans for net zero carbon emissions (E), good staff terms and conditions (S) or diversity in their boards (G). Some ESG investors believe companies with these types of sustainable and socially responsible qualities will be more profitable and less scandal-prone in the long-term. Some of the reasons for this include companies’ ability to maintain good reputations and consumer, employee and investor loyalty, and their willingness to innovate in areas such as clean technology.

Impact Investing (Another type of "Positive Screening")

Finally, on the other end of the spectrum, impact investors’ goal is to have a positive social or environmental impact with their money. Inevitably, impact investors may accept higher risks in exchange for trying new business ideas, such as green technology. In this space, there have been major efforts to mobilize “green” or climate finance to support the transition to “net zero” economies in the future.

 

In addition, activist investors engage with company boards to promote change in areas where they think a company is weak or at risk in ESG.

 

To illustrate, Goldman Sachs made a popular graphic that describes some of the ESG spectrum.

What are examples of ESG factors?

Presently a wide range of factors go into defining ESG. Every investment company, ratings agency and non profit has a slightly different list, and some go into incredible detail.

 

Obviously these are some major examples of ESG factors:

Common ESG factors

ESG for beginners: Who invests in ESG?

Pension funds and insurance companies are the biggest ESG investors. Undoubtedly, insurance companies’ profits could be hit hard by climate change in the future. So many invest in low-carbon companies and solutions to climate change.

 

Moreover, pension funds want to manage ESG risks to their funds because they must act in their members’ best interests. A growing number of pension fund managers interpret their fiduciary responsibilities to include protecting investors from excessive risk exposure to climate change and related economic shocks and natural disasters.

 

Furthermore, Millennial and Gen X investors are choosing ESG funds which match their belief systems and financial goals. Millennials will inherit about $30 trillion over the coming years and they will drive ESG in the future.

Undoubtedly, insurance companies’ profits could be hit hard by climate change in the future.

What are the risks of ESG?

Importantly, ESG reporting and exact definitions are not yet regulated in many jurisdictions. The Securities and Exchange Commission is finalizing ESG reporting requirements. Nevertheless, for now US industry standards for investors and investees are all voluntary. Around the world, regulators are in the process of introducing voluntary and mandatory disclosure rules. ESG Hive’s Quick Start Guide to Global ESG and Sustainability Standards covers the latest developments in many areas, including the African Union, China, the EU, India, Japan and the USA.

 

Consequently, it is very important to understand the ESG regulations where you live and what is really involved in the ESG products on offer to you. Public companies, ratings agencies and investment companies are not always being completely transparent about their methods and how sustainable and socially responsible their offerings are. It is up to you to find out whether products align with your ESG values and goals, or whether the companies behind them are using these greenwashing marketing tricks.

ESG for Beginners: Do you know what your goals are?

Become an insider: Where can ESG beginners start?

As you embark on ESG investing, it is important to decide what you want to accomplish and what professional help you will need to achieve your goals.

 

ESG Hive is an educational resource in your journey to being an ESG insider. Best of all, we offer quick learning resources, and opportunities to test yourself on your goals and new-found knowledge. For example, you can test how much you know about clean energy.

 

You can browse our categories if you already know which aspects of ESG matter to you. You can select from Environmental, Social and Governance categories or look deeper into our ESG Investing categories. 

 

Take our quiz to help you think more deeply about what aspects of ESG investing do or don’t matter to you.

 

You can also subscribe to our newsletter to stay informed.

 

We love to hear from our readers! If you have an idea for a contribution or have comments and questions, there are lots of easy ways to  get in touch with us.