Introduction to ESG Investing - What is it?

Did you know that you can do good by investing? You can with ESG investing! There is a steady growth in ESG investments as more investors, especially younger generations, are looking to invest in companies that reflect their values while generating financial returns. Morgan Stanley Institute for Sustainable Investing reported in their 2021 survey that a majority of millennials (99%) expressed interest in sustainable investing.

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What is ESG Investing?

Both ESG and traditional investing share the same objective - financial returns. However, ESG investing has other objectives besides financial returns. ESG investing, also known as sustainable investing, is a type of investing that takes into environmental, social, and governance (ESG) considerations besides economic factors. Examples of ESG considerations include:

Environmental Considerations:

• Biodiversity

• Climate change

• Deforestation

• Greenhouse gas (GHG) emissions

• Water management

Social Considerations:

• Diversity, equity, and inclusion

• Equal opportunities

• Health and Safety

• Human rights

• Working conditions

Governance Considerations:

• Board composition

• Corruption

• Cybersecurity

• Risk management

• Shareholder democracy/rights

Difference between ESG Investing and Socially Responsible Investing (SRI)

People refer to ESG investing as socially responsible investing and vice versa. Both investments are very similar to one another, but they are two different types of investing. ESG investing emphasizes practices that enhance ESG performance, while socially responsible investing focuses on avoiding practices that negatively impact ESG performance. A socially responsible investor would not invest in companies involved in sin stocks. Some examples of sin stocks include:

• Alcohol

• Gambling

• Tobacco

• Weapons

Profitability of ESG Investments

One main concern regarding ESG investment is financial performance. The fact that ESG investing does not solely depend on economic factors in investment decisions led people to doubt its financial performance. Despite people’s concerns, ESG investments can generate stable financial returns. Morgan Stanley published a Sustainable Reality study that shows the "median total return for U.S. sustainable equity funds was 4.3 percentage points higher than traditional funds" in 2020.

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ESG Investment Strategies

There are different strategies for ESG investment. Here is a list of ESG investment strategies:

• Active ownership

• ESG integration

• Impact investing

• Screening

• Negative screening

• Positive screening

• Thematic investing

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Active Ownership

In the case of active ownership, investors hold shareholder rights, which means they have the power to influence the trajectory of the company they invested in. Investors actively engage and vote in ESG-related matters to optimize ESG strategies and practices.

ESG Integration

In the ESG integration strategy, the ESG materiality is assessed to identify risks and opportunities, and the data from the ESG materiality assessment is incorporated into investment decisions to mitigate risks in the company while maximizing the financial return.

Impact Investing

Investors who adopt the impact investing strategy expect measurable contributions to the environment or society on top of financial returns. Let's say an investor wants to positively impact the environment by investing in renewable energy, so they invest in companies or projects that support renewable energy initiatives and have a clear expectation of financial return.

Screening

Among the listed strategies, screening is the most implemented strategy in ESG investment. Within the screening strategy are two ways to screen companies: negative and positive. The negative screening filters out companies with poor ESG performance, while the positive screening only selects the top ESG-performing companies. An example of negative screening is an investor setting the investment criteria so that companies with high carbon emissions are excluded from the mutual fund portfolio. In the case of positive screening, the investor would set the investment criteria, so it only filters in the top companies with low carbon emissions.

Thematic Investing

Thematic investing is a long-term investing strategy that bases its investment selection on a macroeconomic trend. Thematic investors seek companies that will positively contribute to a specific trend in the long run. People may confuse thematic investing with sector investing. Sector investing is when investors invest in a particular economic sector. In thematic investing, the trend is not classified as a specific sector; therefore, thematic investing can cross multiple different sectors.

Concluding Thoughts

ESG investing does not always guarantee a financial return, and it does not guarantee an environmental or social impact either. However, there is value in the investor's intention to do good by investing in companies that engage in ESG practices.