Summary
- ESG, which stands for “Environmental, Social, and Governance,” can be defined as categories of risks and opportunities that businesses and investors take into account when making decisions about how to run a business or how to invest money.
- Responsible investing means investors are considering how financial risks like ESG impact an investment’s long-term success.
- While this is not an exhaustive list, the “E” includes reducing emissions, water consumption, and plastics usage. The “S” focuses on better working conditions, fair pay and benefits, and racial equity oversight. The “G” concerns leadership maintaining accurate and transparent accounting practices, reasonable executive compensation, and board and leadership diversity.
- ESG matters because it helps businesses and investment managers assess a wide range of risks that could affect their company or portfolio performance.
- Strong ESG practices can lead to more resilient, long-term successful companies and overall returns on investment portfolios.
What is ESG?
ESG stands for “Environmental, Social, and Governance,” which are categories of risk and opportunities that businesses and investors take into account when making decisions about how to run a business or how to invest money. Taking Environmental, Social, and Governance factors into consideration is part of a responsible business or investment strategy. It’s a way for businesses and investors to understand how companies are performing and handling a range of financial risks that fall under these three categories.
Companies’ practices on Environmental, Social, and Governance issues can have an impact on their current and future performance. They can also have an impact on the environmental, social, and financial systems upon which the overall value of an investor’s portfolio depends, as portfolios are often composed of many different investments reflecting a wide cross-section of the economy. Therefore, there is tremendous value in understanding long-term risks and opportunities associated with these factors.
Does ESG matter?
Environmental, Social, and Governance factors matter because businesses and investment portfolios face a wide range of risks and opportunities. Consideration of these risks and opportunities is generally considered a good business practice. Research has shown that companies with strong ESG practices may be more resilient and successful in the long term, because they are taking into account a wide range of risks and opportunities. Research has also shown that risks that affect investments across the board and not just specific companies — including risks to our environmental, social, and financial systems that individual companies can either contribute to or help counteract — account for up to 94% of the variability of investment returns.
Understanding ESG ratings
ESG ratings are evaluations of a company’s performance in environmental, social, and governance (ESG) areas. These ratings are created by research and ratings companies, who use a variety of data sources to assess companies on a large number of ESG metrics, providing them with a score to determine how well they fare according to their own methodology. These metrics can include a company’s energy use, waste, pollution, natural resource conservation, treatment of employees, community engagement, and management structure.
Unfortunately, ESG ratings are not well-regulated and can be very misleading: a company might rank highly in one ESG rating because its governance policies fit all the requirements of the rating company, yet it might be a major polluter. Regulators around the world are beginning to assess how ESG rating providers can be better regulated to provide clearer information to the markets so that institutional and retail investors are not misled.
Last modified: November 17, 2023
