Why ESG Investing Matters

People prefer to put their money into companies that care. That's one of the many reasons why ESG investing matters.

POSTED July 7, 2020

Social responsibility is increasingly important to consumers. A 2019 study showed 37% of shoppers say they seek out and are willing to pay more for environmentally friendly products – and younger generations feel even more strongly about it. Knowing this, shareholders are beginning to think more critically about the environmental and ethical implications of their investments. When investors start to align their money with their values, this shareholder activism puts pressure on businesses to better align with those values.

In 2019 the CEOs of nearly 200 companies, including giants like Boeing and General Motors, announced that creating value for shareholders was no longer their top priority. Instead, they proclaimed their commitment to supporting communities, dealing ethically with stakeholders, and investing in employees. This is an example of the growing popularity of ESG investment, a trend you can’t afford to ignore.

What is ESG investing?

ESG investing refers to environmental, social, and governance, three primary factors for measuring the sustainability and societal impact of investing in a particular company.

  • Environmental: Data related to how business operations contribute to – or mitigate –pollution, waste, wildlife habitat destruction and greenhouse gases. Environmental investment will be the focus of this post.
  • Social: Factors that describe how a company’s operations affect society, such as diversity and inclusion, human rights, consumer protection and animal welfare. Companies whose practices aren’t in line with consumers’ values are less likely to attract or maintain investors. But it’s not just about popularity. In the case of diversity and inclusion, for example, ignoring best practices may create issues with discrimination or harassment that leave the company open to costly lawsuits. Problems with diversity and inclusion also affect a company’s ability to hire and retain the best talent, which in turn affects the quality of the work.
  • Governance: Sometimes called “corporate governance,” this can include everything from executive compensation to management structure to employee relations. Does the CEO have too much power over the board? Are executives receiving lavish salaries and bonuses while lower-level employees are being laid off or underpaid? Do employees feel good about working for this company, or are they unhappy with management decisions? These are just some of the question’s investors might ask when assessing a company’s corporate governance.

Investors know the stakes are high

The threat of climate change increases every day. Without drastic reduction in greenhouse gases, scientists warn, humans are in for “untold suffering” due to climate change. Global warming will lead to stronger hurricanes, more droughts and floods, more intense heat waves and cold snaps, rising sea levels, and agricultural failure. All of these will threaten people’s health, safety and property.

Investors are increasingly taking notice. In 2018, investors considered factors of social responsibility for more than $30.7 trillion of professionally managed assets globally. That’s a 34% increase in the past two years. On the issue of climate change and carbon emissions, the message is even clearer: in the United States, these environmental factors were the top criteria for ESG investing, accounting for $3 trillion in assets, a 110% increase over 2016.

Environmental factors influence where investors put their money, but they also influence where they choose not to put their money. Divestment from fossil fuels is an increasingly common strategy for ESG investors. The energy sector has already decreased from 16% of the S&P 500 in 2008 to 5% today, and experts predict it will continue shrinking as alternative fuel sources become more widely available and Americans become less reliant on cars for transportation.

Meanwhile, sustainability presents new opportunities. Major tech companies like Amazon, Microsoft and Apple have pledged to work toward carbon negative status. That means their business operations will remove more CO2 from the air than they pump into it.

ESG ratings is about more than just values

While some investors have genuine concern about protecting the environment and reducing carbon emissions, they also see ESG investing as a risk-management strategy. Companies that aren’t run sustainably are less viable long-term. ESG issues like climate change and pronounced inequality are threats to a functional society and, in turn, to financial stability. Investing in companies and industries that contribute to a balanced, functioning society — and divesting from those that disproportionately contribute to these threats — will deliver long-term value.

In addition to regulating finance and industry, governments can influence the long-term viability of companies with unfavorable ESG ratings through infrastructure and other policies. Large-scale efforts to change consumer behavior — for example, incentivizing public transportation and disincentivizing private vehicles — will hurt businesses that don’t adjust to changing demands. In contrast, socially conscious companies are popular with consumers, inspiring strong loyalty among shoppers who are passionate about mitigating the effects of climate change.

Criteria for environmental responsibility

Business and industry can affect the environment in many ways. How does this company manage its carbon footprint? What efforts does it make to divert waste from landfills? Is this business contributing to deforestation or water contamination? What’s its track record as far as complying with environmental regulations? These are all questions you might ask to assess the environmental sustainability of a company before investing.

Investors are not required to report ESG data in the United States, but many choose to include some of these metrics. Over 7,000 companies worldwide now provide voluntary reports to the Carbon Disclosure Project (CDP). Organizations like the Sustainable Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and CDP are working to create standards to more uniformly incorporate these factors into the investment process, and more than 600 firms and schemes, including RobecoSAM Corporate Sustainability Assessment, Sustainalytics, MSCI, and Bloomberg ESG Disclosure Score, provide ratings and rankings that inform investors with their own investment risk analysis.

In fact, Individual investment firms report using multiple data sources to inform their own assessments when it comes to socially responsible investments. For example, Trillium Asset Management avoids investing in energy companies that derive 10% or more of their revenues from coal, or businesses with 1% or more of their revenues coming from nuclear weapon sales.

ESG investing – the bottom line

Showing your commitment to social and environmental responsibility is a smart strategy as investors and consumers increasingly look for businesses that have a positive impact on their communities and the world. Taking steps toward reducing your company’s carbon footprint and communicating that progress to potential investors will help you stand out within your industry.