When it comes to making investment decisions, more and more individuals and organizations consider environmental, social, and governance (ESG) factors. ESG investing focuses on companies that are considered to be leaders in sustainability and have a positive impact on the environment and society.
If you’re interested in ESG investing, it’s essential to understand the nuances, benefits, and risks of this growing trend. It would help if you did the research to make sure you invest in companies that align with your values and follow ESG standards.
ESG, which stands for environmental, social, and governance, refers to non-financial criteria that investors use to determine whether companies are socially and environmentally responsible.
There is, however, no universally shared set of ESG criteria used by all investors or financial firms to evaluate a company’s soundness or risk along these lines. Nonetheless, the following are some of the most common factors that investors consider when evaluating ESG standards.
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The environmental component of ESG criteria might include metrics on a company’s energy emissions, waste, and water usage. Investors may also focus on the risks and opportunities associated with the impacts of climate change on the company and its industry.
Some company information that environmentally conscious investors may evaluate include:
• Pollution and carbon footprint
• Water usage and conservation
• Renewable energy integration (such as solar and wind)
• Climate change policies
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The social component of ESG generally describes the impact of a company’s relationships with people and society. Factors as varied as corporate culture, commitment to diversity, and how much a company invests in local organizations or communities can impact socially-conscious investors’ decisions on buying into a specific corporation.
Some other social factors can include:
• Employee pay, benefits, and perks
• Diversity, equity, and inclusion
• Commitment to social justice causes
• Ethical supply chains (e.g., no sweatshops, conflict-free minerals, etc.)
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The governance component of ESG generally focuses on how the company is run. Investors want to know how the board of directors, company, and shareholders relate to one another.
Some additional governance factors that investors evaluate include:
• Executive compensation, bonuses, and perks
• Diversity of the board of directors and management team
• Transparency in communications with shareholders
• Rights and roles guaranteed to shareholders
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What Is ESG Investing?
ESG investing is a type of strategy that considers environmental, social, and governance factors when making investment decisions. Investors use these criteria to screen potential investments; if a business’s operations don’t follow ESG standards, investors may avoid putting money into the company.
There are several reasons people and institutions might choose to invest in companies that prioritize ESG factors. For some, it is a way to align their values with their investment portfolio. Others believe that companies that take ESG factors into account are likely to be more financially successful in the long run.
But, as mentioned above, there is no agreed-upon set of standards for what makes a company ESG friendly. Companies committed to ESG operations may publish sustainability reports to give investors some insights into the firm. Additionally, third-party organizations have stepped in to create ESG scores for companies and funds based on their adherence to various ESG factors.
How ESG Scores Work
ESG scores – sometimes called ESG ratings – are designed to measure a company’s environmental, social, and governance performance. Investors use them to assess a company’s risks and opportunities concerning these three areas.
An ESG score is calculated by analyzing a company’s data on environmental, social, and governance policies and practices from various sources, like SEC filings, government databases, and media reports.
A high ESG score means a company manages ESG risks better than its peers, while a low ESG score means the company has more unmanaged ESG risks. Evaluating a company’s ESG score, along with financial analysis, can give investors a better idea of the company’s long-term prospects.
Some of the most prominent ESG score providers are MSCI, Morningstar Sustainalytics, and S&P Global.
ESG vs SRI vs Impact Investing
ESG investing is sometimes called sustainable investing, impact investing, or socially responsible investing (SRI). However, impact investing and socially responsible investing are often viewed differently than ESG investing.
Some of the differences between the three investment strategies are:
• ESG investing focuses on a company or fund’s environmental, social, and governance practices and traditional financial analysis.
• Socially responsible investing eliminates or selects investments according to specific ethical guidelines. Investors following an SRI strategy may avoid investing in companies related to gambling and other sin stocks, along with companies that may damage the natural environment.
• Impact investing is generally done by institutional investors and foundations. Impact investing focuses on making investments in companies or projects specifically designed to generate positive social or environmental impact.
Types of ESG Investments
Investors can make ESG investments in the stocks and bonds of companies that adhere to ESG criteria or have high ESG scores. Other potential investment vehicles are mutual funds and exchange-traded funds (ETFs) with an ESG strategy.
Buying stocks of companies with environmental, social, and governance commitments can be one way to start ESG investing. However, investors will often need to research companies that have ESG credibility or rely on third-party agencies that release ESG scores.
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The bonds of corporations involved in ESG-friendly business practices can be a good option for investors interested in fixed-income securities. Green and climate bonds are bonds issued by companies to finance various environmentally-friendly projects and business operations.
Additionally, government bonds used to fund green energy projects can be an option for fixed-income investors. These bonds may come with tax incentives, making them a more attractive investment than traditional bonds.
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Mutual Funds and ETFs
Investors who don’t want to pick individual stocks to invest in can always look to mutual funds and exchange-traded funds that provide exposure to ESG companies and investments. A growing number of index funds invest in a basket of sustainable stocks and bonds. These funds allow investors to diversify their holdings by investing in one security. However, not all ESG funds follow the same criteria and may focus on different aspects of environmental, social, and governance issues.
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Benefits of ESG Investing
ESG investing has several benefits, including:
• Improving long-term financial performance: A growing body of evidence suggests that companies with solid ESG ratings may be good investments. They tend to outperform those with weaker ratings, both in share price performance and earnings growth.
• Mitigating risk: ESG factors can help identify companies with poor governance practices or exposure to environmental and social risks, leading to financial losses.
• Creating social and environmental impact: By investing in companies that are leading the way on environmental, social, and governance issues, investors can help drive positive change and make a positive impact on society.
These potential benefits are increasing the popularity of ESG investing. According to Bloomberg, global ESG assets may surpass $41 trillion by the end of 2022 and reach $50 trillion by 2025, up from $22.8 trillion in 2016.
How to Start an ESG Investment Portfolio
If you are interested in creating an ESG portfolio, you can start by contacting a financial advisor that can help you shape your investment strategy.
However, if you are ready to start investing and want to build a portfolio on your own, you can follow these steps:
• Open a brokerage account: You will need to open a brokerage account and deposit money into it. Once your account is funded, you will be able to buy and sell stocks, mutual funds, and other securities. SoFi Invest® offers an active investing platform where you can start building your ESG portfolio.
• Pick your assets: Decide what type of investment you want to make, whether in a stock of a company, an ESG-focused ETF or mutual fund, or bonds.
• Do your research: It’s important to research the different companies and funds and find a diversified selection that fits your desires and priorities.
• Invest: Once you’re ready, make your investment and then monitor your portfolio to ensure that the assets in your portfolio have a positive social and financial impact.
It is important to remember that you should diversify your portfolio by investing in various asset classes. Diversification will help to reduce your risk and maximize your returns.
ESG Investing Strategies
ESG investing can be different based on values and financial goals. It’s therefore essential to start with your investment goals and objectives when crafting an ESG investing strategy. Consider how ESG factors can help you achieve these goals.
It’s also crucial to understand the data and information available on ESG factors; this will vary by company and industry. When researching potential ESG investments, you want to make sure a company has a clear and publicly-available ESG policy and regularly discloses its ESG performance. Additionally, it can be helpful to look at third-party scores to determine a company’s ESG performance.
If you want to learn more about ESG investing, several resources are available online and from financial advisors. Doing your research and talking to a financial advisor can help you determine if ESG investing is right for you.
There is no “right” way to invest in ESG companies. What matters most is that you are comfortable with the companies you are investing in and believe in their ability to create long-term value.
Investors interested in making ESG investments can use the SoFi app to help. With SoFi Invest®, you can trade stocks and ETFs to build an ESG portfolio. And if you’re not ready to pick stocks and ETFs by yourself, SoFi’s automated investing tool will build a portfolio for you with no SoFi management fee.
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