Table of Contents
ESG investing strategies continue to garner strong interest among investors, as well as corporate executives and governments. As recent climate and geopolitical events have underscored, companies today face a range of risk factors that may be mitigated by embracing certain environmental, social, and governance standards.
And while many organizations have established methods for evaluating and scoring companies on how well they meet certain ESG benchmarks, there is still no globally accepted set of standards for evaluating and rating company performance according to ESG criteria.
Thus, investors face two potential types of risk when it comes to ESG investing. First, companies have material challenges with regard to environmental, social, and governance factors, which require ongoing remediation.
But, owing to the lack of widely accepted ESG frameworks and metrics, it can be difficult for companies to evaluate their own progress toward ESG targets — and likewise for investors to then evaluate which companies meet ESG targets and which don’t.
Despite the inconsistencies in how various ESG criteria are applied from company to company, however, industry research suggests that ESG funds are competitive with funds that adhere to more conventional strategies.
Key Points
• Companies today face material risks pertaining to environmental, social, and governance (ESG) factors.
• Many investors now assess company performance in terms of sustainability, in addition to financial factors.
• Nonetheless, investors may find it challenging to assess which companies meet ESG targets, due to inconsistent frameworks, inaccurate reporting, or false claims.
• Lack of clarity around ESG standards can lead to greenwashing (the practice of claiming to meet ESG standards when you don’t).
• Companies which fail to implement effective ESG strategies may face regulatory, reputational, and financial risks.
The State of ESG Standards
In the last 10 years or more, the need to identify and solve for ESG risk factors has prompted numerous organizations to try to develop ESG criteria that companies must meet, as well as ways of measuring and disclosing whether they’ve attained specific ESG targets.
In theory, companies that fail to meet certain ESG criteria (e.g., efficient energy use, pollution mitigation, diversity targets, transparency in accounting) would be able to improve their efforts and thereby mitigate those risk factors.
But the persistent challenge here has been a lack of agreement about how to define and measure, and therefore uphold, meaningful positive strides in terms of key environmental, social, and governance factors.
A Range of Criteria
ESG criteria and metrics are almost impossible to describe, owing to the wide assortment of public and private (e.g., proprietary) frameworks.
These include the United Nations’ 17 Sustainable Development Goals, a set of nonbinding principles that some organizations use as guidelines, as well as frameworks for reporting and disclosures developed by other nonprofits, such as the Global Reporting Initiative (GRI) and International Financial Reporting Standards (IFRS) Sustainability Disclosure Standards. In addition, some financial companies themselves have their own proprietary measures.
In recent years, for example, the Securities and Exchange Commission (SEC), which oversees the securities industry in the U.S., has undertaken the task of combating the practice of so-called greenwashing by permitting financial firms to label funds “ESG” only when the vast majority of holdings (80%) include ESG investments.
In addition, in March of 2024, the SEC announced a set of climate-disclosure rules that would apply to all U.S. companies of a certain size. But, in a testament to an industry riven by discord on how sustainable investing should be defined, just a month after issuing new rules that would standardize companies’ climate disclosures, the SEC responded to a spate of criticism and temporarily stayed the ruling. In June of 2026, the SEC published a proposal to rescind the climate-related disclosure rules.
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ESG vs Conventional Strategies
Conventional strategies tend to focus on financial and industry metrics such as profit and loss statements, competitive analysis, and so forth. ESG investing introduces new categories with which to evaluate companies beyond their financials. While ESG is a type of sustainable investing strategy, the term ESG is more specific in that companies must focus on positive environmental, social, and governance outcomes.
The benefit of ESG and other impact investing strategies is that they can help investors put their money toward ethical companies that are doing good in the world. Again, as noted above, ESG funds may offer returns that are comparable to conventional funds.
5 Risks of Investing in ESG Stocks
As highlighted earlier, despite the steady interest in socially responsible investing strategies such as ESG, the quality and consistency of reporting frameworks and metrics have lagged.
Industries and agencies need to establish agreement about ESG frameworks, implementation, disclosures, reporting, and compliance. Given the current hurdles, investors should bear in mind relevant risk factors.
Five key risks of ESG investing include:
Lack of Support for ESG Standards
Companies can decide to embrace ESG standards and hire third-party evaluators, but if their employees and executives aren’t knowledgeable about or in support of using ESG criteria, due diligence and compliance will suffer, and the company may not reach its goals.
Weak Monitoring
Related to the lack of support for ESG frameworks and standards, many companies may lack robust systems for implementing, monitoring, and tracking ESG metrics, making it difficult to produce accurate reports and ratings.
Compliance May Not Support ESG Frameworks
Even if a company has a comprehensive set of ESG standards, they may not have a thorough compliance program that keeps tabs on ESG issues — and/or ESG standards aren’t well-integrated into risk evaluation assessments.
Inaccurate Reporting
When a company decides to adhere to a certain set of ESG standards, they also need to install control mechanisms to ensure accurate reporting. The SEC reported that many companies distributed disclosures and marketing materials, making them look more sustainable than they really were in practice, or with old information that needed updating, because they didn’t have adequate internal checks and balances.
Lack of Diligence Among Fund Managers
The SEC notes that portfolio managers need to review company policies and procedures in regard to ESG factors before investing in that firm.
Why Companies May Want to Reduce ESG Risks
Not only are the above risks to investors, but they also pose risks to companies:
• Strategic: The idea behind ESG is that the three pillars measure a company’s overall commitment to making positive strides in those areas. If a company fails to implement ESG strategies, it could affect its long-term prospects.
• Regulatory: Failure to comply with regulations, such as those that reduce environmental risks and prevent illicit practices, can directly impact a company’s ability to do business and meet shareholder expectations.
• Reputational: If a company misleads investors, consumers, and other stakeholders, it could taint its reputation and lead to financial losses.
• Financial: It has been shown that strong ESG metrics may help a company financially. Not only can false ESG reporting lead to fines, but failure to implement ESG plans can also mean a company hasn’t maximized its chance to offset certain risks and increase profits.
How ESG Mitigates Some Risk Factors
While there are risks involved with ESG-focused investing, companies that seek to embrace ESG standards may also mitigate some risk factors for investors.
Investors may benefit by investing in companies that are proactively addressing the challenges of a changing world. For example, implementing a regular risk-assessment review process may help companies identify and plan for emerging risks that may include:
• Environmental: Preventing pollution and other hazards, complying with regulations, mitigating and adapting to climate risks, investing in renewable energy and energy-efficient systems
• Social: Maintaining a diverse workforce, building relationships with communities, governments, and other stakeholders
• Governance: Maintaining a strong leadership culture, preventing fraud and illicit activity, supporting transparency in accounting and management practices
With this in mind, investors may research companies or funds to assess if they’re meeting their own commitments. What are their reporting and disclosure practices? Are they using one of the more well-known standards? Is their information verified by a third party?
The Takeaway
Understanding ESG risks can help investors make more informed decisions about their investment choices. Investors interested in putting their money into sustainable companies can use existing ESG metrics to evaluate suitable options but should be aware of the potential downsides.
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FAQ
What are the main risks of ESG investing?
Like any investment strategy, ESG investing comes with risks. One challenge is that ESG ratings and standards can vary widely, making it difficult to compare companies or funds. Investors may also encounter greenwashing, where a company or fund appears more sustainable than it actually is.
Can ESG investments perform as well as traditional investments?
ESG investments may perform similarly to traditional investments, but results can vary depending on market conditions and the specific investments involved. A company’s ESG practices are only one factor that can influence performance. So investors should consider their overall goals, risk tolerance, and investment strategy.
Why is it difficult to evaluate ESG investments?
Evaluating ESG investments can be challenging because there is no single global standard for measuring environmental, social, and governance factors. Different rating agencies may use different criteria and methodologies, which can lead to varying ESG scores for the same company. As a result, investors often need to look beyond a single rating when researching an investment.
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