ESG investing: meaning and trends

ESG investing has proven one of the most durable investment trends over the past decade. Learn why all kinds of investors support ESG funds and investments.

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ESG investing has significantly altered the way we think about investments. With the decline of investing solely for returns, ESG investing expects returns that have societal benefits as well. 

The acronym “ESG” stands for environmental, social, and governance performance, which alongside profits represent the societal values a company can provide. Balancing these diverse forms of value is important for ensuring long-term business sustainability. 

 

❓What is ESG investing?

ESG investing prioritizes environmental, social, and governance factors and performance alongside the profits of an organization. It considers both the material risks and opportunities businesses face related to these factors.  

Several other terms that are sometimes used interchangeably “ESG investing”:

  • Sustainable investing
  • Impact investing
  • Socially responsible investing
  • Ethical investing

As part of sustainable development, ESG investing prioritizes a long-term outlook over short-term profits with high environmental and social costs. This style of investing aims to preserve rather than deplete the environmental and human resources businesses depend on, while still making profits.

Indeed, ESG investments are becoming more popular as consumer demand and regulatory pressures for both environmental and social responsibility have grown. 

Where there is no mandate, businesses sign on to voluntary corporate social responsibility standards and frameworks to track, report and communicate their ESG performance. 

These include CDP, the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD). Annual CSR reporting helps investors evaluate and compare business performance.  

ESG investors use ESG investment indices such as the Dow Jones Sustainability Index (DJSI), Morgan Stanley Capital International (MSCI), FTSE4Good, and ISS ESG solutions to analyze ESG rating information. 

Investors themselves may disclose their own sustainability initiatives by following the Principles for Responsible Investing (PRI), which the United Nations established in 2006. These are the most widely-recognized ethical investment guidelines and now have over 2,000 signatories. 

🤔 Why is ESG analysis becoming important to companies?

ESG investing has grown 456% over the past few decades from 2005 to 2020. This growth pairs with a growing interest in individuals and organizations to use their investments to produce positive societal outcomes, not just financial ones. 

Earning high profits does not necessarily require environmental and social sacrifices. Studies have shown that ESG investment performance correlates with financial growth.  

A Fidelity study assessed how well global ESG investments performed from 1970 to 2014 and found that half surpassed the broader market. Only 11% showed poor performance. 

Morningstar research shows that ESG funds show lower volatility and positive returns. Over ten years, 77% of ESG funds remained active compared to 46% of conventional funds. 

This growth is causing investors to expect more disclosures and high-quality data from the companies they invest in. In order to provide accurate ESG ratings, investors depend on the voluntarily reported data provided to them from companies. 

Companies using CSR reporting frameworks help deliver this information in a way that is useful to investors. While companies may fear exposing poor performance, ESG reporting actually gives them greater clarity on their business operations overall. 

ESG improvements don’t always require costly or time-consuming initiatives. Sometimes, they deliver cost-savings and overall operational efficiency improvements. Shifting the organizational mindset towards ethical business helps companies communicate their ethical value to stakeholders.  

This value is so important to consumers that they are willing to boycott brands that don’t prioritize business sustainability. They are also willing to pay more for products from companies that do prioritize ESG factors. 

So far, the lack of consistent and comparable ESG data available has caused the EU, UK, and the US to respond with mandates for ESG financial risk disclosures. 

The UK requires TCFD reporting, the EU has created a Sustainable Finance Disclosure Regulation, and the US SEC has proposed a climate-related risk disclosure similar to TCFD. 

As the impacts of climate change and social inequities intensify, investors will continue to seek out more high-quality ESG investments. The only way businesses can access the opportunities presented by this ESG investment trend is to undergo the process of sustainability reporting and disclosure.  

🔎 What are the ESG factors? 

For voluntary ESG reporting, businesses have traditionally reported their performance according to the issues that are material to their operations. Different ESG frameworks recommend companies report on specific ESG factors such as their greenhouse gas (GHG) emissions. 

Not all factors can easily be categorized into an “E,” “S,” or “G” category, as they often have interconnected impacts. For instance reducing GHG emissions is considered important for climate change and the environment, but it also improves community health, which is a social consideration.  

Increasingly, businesses are also called upon to report the financial risks and opportunities linked to ESG factors. This way, they are not considered in isolation from a company’s bottom-line. However, companies may struggle to quantify ESG factors in financial terms, let alone verify the amounts. 

This is why it is important for businesses to partner with organizations to support them in their quantification of ESG factors. 

Environmental factors 🌱

  • Greenhouse gas emissions
  • Energy efficiency
  • Water consumption
  • Toxic substances and pollution 
  • Biodiversity loss and protection
  • Deforestation 
  • Waste management 
  • Product life cycle analysis

Social factors 👥

  • Human rights and child labor
  • Living wages
  • Worker health and safety 
  • Diversity, equity, and inclusion
  • Data protection and privacy
  • Employee and customer satisfaction
  • Community relations
  • Stakeholder engagement

Governance factors 🏢

  • Board composition
  • Executive compensation
  • Tax strategy
  • Bribery and corruption
  • Lobbying and political contributions
  • Transparency and public disclosures
  • Codes of conduct
  • Supply chain management
  • Risk and crisis management

👀 Are there specific metrics to consider? 

WIth so many different factors included in ESG and so many different business models, there are no standard metrics that companies report on. To prepare for ESG reporting, organizations select the ESG performance metrics material to their business industry and model. 

However, environmental metrics such as GHG emissions are commonly reported, due to the globally binding Paris Agreement target of limiting global warming to well under 2 degrees Celsius by 2100.  

Even for GHG emissions, there are variable methods for measurement. GHG emissions data may be measured in “absolute” or “emissions intensity” terms. 

Absolute emissions measurement reports the total greenhouse gas emissions over a period of time. Emissions intensity shows how much GHG emissions were produced per unit of profit. 

While absolute emissions targets are helpful for assessing performance according to a national carbon budget and achieving net zero, emissions intensity targets allow growing businesses to reduce emissions relative to their growth. 

Assessing ESG performance starts with choosing a baseline year for comparison, establishing key metrics to measure performance, and KPIs to assess improvements. 

📈 What are the main trends in ESG investing? 

Since the COVID-19 pandemic, the importance of business resilience in the face of global disruption came to the fore. Like the pandemic, climate change is also expected to intensify social inequalities and challenges related to adapting to change. 

As a result, 2021 saw the largest amount of sustainable investments totalling $120 billion, according to Bloomberg. This was more than twice the amount invested in 2020. Sustainable investments now make up more than a third of the total global managed assets, and this amount grows each year.   

Sustainable investments could reach an estimated $50 trillion in two decades. ESG investing is seen as both a way to lower the long-term risk profile of investments, and earn higher returns over time. 

Tackling global warming 🔥

The 2015 Paris Agreement made climate change a key focus for global ambition. Net zero GHG emissions targets cover 70% of global GDP combined from national and regional commitment levels. 

US public opinion also favors climate change action. Yale’s climate opinion polls from 2021 show that 72% of people in the US think that CO2 should be regulated and 70% feel that corporations should do more to address global warming. 

With such a strong consensus among policy leaders and public opinion to reduce global GHG emissions, investors increasingly expect businesses to measure, report, and establish reduction targets for their corporate emissions. 

The investment community no longer sees companies as mere contributors to the problem of climate change. It acknowledges that business assets are vulnerable to climate risks. 

These risks include “transition risks” related to regulations, consumer demand, litigation, and shifting technologies. They also include “physical risks” related to climate change such as water scarcity, extreme temperatures, sea level rise, and other complex impacts. 

Direct climate change impacts have totaled $2.195 trillion in damages since 1980, according to the NOAA. Without significantly reducing CO2 emissions, these impacts are expected to increase in intensity and frequency. That’s why climate change has become a “hot” trend within ESG investing. 

Global institutional investors have become more interested in evaluating both physical (77%) and transition (80%) risks in 2021. These numbers are up from 2020, when these figures were 73% and 71%,  respectively. 

Investors have taken a variety of approaches to raise the profile of climate change. For instance, shareholder activist investment firm Engine No. 1 rallied to appoint three new climate-minded board directors to Exxon’s board in 2021. 

As climate risks grow, passive investment could become a relic of the past. 

Considering mental health 😌

The global pandemic also highlighted challenges to mental health related to mourning loss and struggles with isolation and uncertainty. Schedule disruptions and unevenly distributed health and safety protections made people confused and frustrated.  

People had to adapt their expectations for things as mundane as travel, socializing, and dining to reduce the risk of spreading disease. 

All of these impacts heightened the number of people in the US facing depression (64%) and anxiety (57%). Five times as many people visited mental healthcare facilities as in pre-COVID times. At least one team member quit due to burnout for 25% of businesses in the UK.   

The emotional toll on the workforce can have compounding effects that reduce the morale of team members beyond those most directly impacted. Overall, this can affect the profits and reputation of businesses. 

Work-life balance, flexible work schedules, and opportunities for career advancement can all help employees engage more meaningfully at work. Mental health is an important ESG consideration for investors, because it correlates with stronger productivity and financial returns. 

Focus on social inequality ⚖️

Social inequities hit the world hard during the pandemic. Mothers had to find childcare or sacrifice work when their children could not attend school. Systemic racism gave people of color a greater risk of infection from COVID-19.

Across supply chains, people lacking economic safety nets had to risk their lives to continue producing the world’s commodities. In contrast, global wealth soared during this time, creating a greater divide between the world’s wealthiest and poorest individuals.  

Employees frustrated by the level of social inequality have taken efforts to form unions, go on strike, and demand stronger health and safety protections, living wages, and equal pay across gender and race. 

Social inequality not only wears down on the performance of a company, it threatens organizations with reputational damage that can last for years. Nike spent over a decade recovering from campaigns and lawsuits highlighting its sweatshop labor practices in the 1990s. 

Companies which prioritize greater equality within supply chains and their own workforce can maintain strong relationships with their diverse stakeholders. The benefits of lower turnover, greater brand loyalty, and increased productivity are all vital for positive financial performance. 

Moving to a sustainable society ✌️

Moving towards a sustainable society is very important to young people who want to make ethical choices in food, fashion, etc. People know that their lifestyles and choices contribute to global issues of waste, climate change, and inequality. 

Many people, especially millennials and Gen-Z consumers, are opting for vegan or organic food, second-hand fashion or sustainable brand clothing, eco-conscious travel destinations, and products with low waste or plastic-free packaging options. 

Consumers are consciously choosing biodegradable or reusable products and packaging to live zero-waste or low-waste lifestyles. They are more likely to compost and save water or electricity when possible. 

The plant-based protein industry is now valued at $20 million. Mainstream fast food restaurants are beginning to offer plant-based menu options to respond to this growing trend. Alternative meat start-ups like Impossible Burger have successfully tapped into the demand for meatless options. 

Second-hand apparel has grown 21 times faster than the market for new clothing. Online shopping and reselling, as well as cheaper price points have made second-hand clothing convenient to buy and sell. People can upload and sell directly from their closets on apps like Depop, Poshmark, and Etsy. 

Resellers specializing in brand name clothing like ThredUp, Vestiaire Collective, and the RealReal also created a high-end equivalent of the second-hand clothing marketplace. 

Traditional retail clothing sellers like Patagonia, Levi’s, and Eileen Fisher have also started to buy back their inventory to resell their own used inventory at a lower cost. This way, brand-loyal shoppers can support the companies at lower price points. 

Sustainable lifestyle choices are likely to grow in importance as more people respond to global shifts by changing their personal habits. Companies that offer relevant low-waste, ethical opportunities for consumers are likely to reap financial rewards.  

🌿 What about Greenly?

Greenly helps prepare businesses to report strong ESG credentials that ESG investors care about. ESG investing is slated for continued growth and it represents an important opportunity for businesses to align with. 

Greenly can help you make the shift toward an ESG-friendly business strategy. Book a demo of our platform today.

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