What is ESG Investing & How Does It Work? | Public.com (2024)

Table of Contents:

1. What is ESG investing?
2. Unpacking ESG investing
3. How ESG investing works
4. How ESG investing is measured
5. How to get started with ESG investing
6. Benefits and limitations of ESG investing
7. How to find ESG investments
8. The bottom line

Although we’ve been more conscious of our changing environment, the last few years have been challenging for most, as we’ve discovered an even deeper need for conservation and sustainability. As more investors embrace social responsibility, there’s been a renewed interest in what’s called “ESG investing.” But, you may be wondering, what does ESG stand for?

What is ESG investing?

According to Investor.gov, ESG stands for environmental, social, and governance, and ESG investing is a strategy that focuses on a company’s dedication to one or more of these factors. These factors are non-financial aspects that evaluate the sustainability of a company and can be broken down like this:

• Environmental – Looks at the overall conservation of the natural environment and what impact the company may have on it, such as toxic chemical use, its manufacturing processes, and carbon footprint.
• Social – Reviews how people are treated by the company, which includes both employees and non-employees. These factors include inclusion programs, race diversity, equality, and how the company supports social programs beyond the company walls.
• Governance – Is how a company is run. This includes how management contributes to positive change and relates to and responds to employees, suppliers, and shareholders alike.

Proponents of environmental, social, and governance (ESG) investing focus on an overall attitude to promote positive changes for all.

Key takeaways

• Many investors are putting their money into companies whose values align with their own concerning social responsibility and environmental sustainability.
• ESG stands for environmental, social, and governance. The premise of this investing strategy is to evaluate those factors, as well as a company’s financial stability, in the market.
• There are 3 styles of investing that focus on issues related to social values. They include environmental, social, and governance (ESG), socially responsible investing (SRI), and impact investing.

Unpacking ESG investing

ESG investing is also commonly referred to as sustainable investing, impact investing, and socially responsible investing (SRI). However, even though these terms may be used interchangeably, there are differences.

ESG is the process of measuring the sustainability of a company in 3 categories that include environmental, social, and governance. Its primary focus is to reduce a negative impact on society and instead provide benefits for the greater good.

What is socially responsible investing?

Socially responsible investing (SRI) involves researching investments that match an investor’s social and environmental values, excluding those companies that profit from harmful practices like environmentally unsafe products, child labor, and corruption, to name a few.

While ESG investing considers the practices of a company regarding policies and procedures and how they impact profitability, SRI focuses on the investor’s values.

Here’s an example of the difference between the two: If you, as an investor, believe health is an important issue and regard any company that produces products that don’t align with your values, such as those associated with vaping, tobacco, and fast food, to be a problem for you, your investment strategy would include avoiding investment in those types of companies.

But, if you’re a fan of the ESG investment strategy, you may not care what products a company produces, as long as the company meets high standards in its management and social policies and has a clean environmental record.

What is corporate social responsibility investing?

Corporate social responsibility (CSR) investing aims to self-regulate and practice corporate social responsibility during regular day-to-day operations. They’re conscious of their impact on society, which includes social, environmental, and economic factors, and operate in a manner that adds value rather than having a negative effect.

An example of this is when an eyeglass company implements a program to donate a pair of glasses for every pair sold, or a shoe company sends shoes to children in poor communities. Some corporations may implement a volunteer matching program where employees are paid a certain amount of money by the company for each hour they volunteer to local charities.

How ESG investing works

In recent years, many investors have made conscious efforts to invest in companies that align with their own values, and it hasn’t gone unnoticed. The strategy is focused on excluding any company that disregards their negative impact on people or the environment, such as with products that do harm. These types of products may include nuclear power, firearms, tobacco, alcohol, and pollutants, or a company may have unsafe business practices or unethical revenue generation practices.

Investors seek out investment opportunities that positively impact the environment and society as a whole and build their investment portfolios on those companies exclusively.

ESG investing offers investors an opportunity to do good through their investments with socially and environmentally responsible businesses. With the popularity of ESG investing, more brokerage firms are offering exchange-traded funds (ETFs), mutual funds, and other investments that meet ESG rating criteria.

Here’s a list of ESG factors considered.

Although many investors are turning to ESG investing, not all issues in each category hold the same weight in the decision-making process. Despite a company’s focus on meeting ESG criteria, most can’t prioritize every issue in their business practices.

Just as we may put some values ahead of others in our personal lives, companies also must choose those values they think will make the most impact regarding their type of business, the industry they specialize in, and their location.

Each of us has different values and motivations for supporting specific companies, but a few of the most prominent issues investors may be influenced by include:

• Workplace diversity and equal rights/opportunities for all. This includes having a diverse management team, employees of different backgrounds, gender identities, and ethnicities, and the ability to work in a positive and supportive environment.
• A company’s focus on eliminating practices that negatively affect issues surrounding climate change and environmentally unsafe practices, such as energy use and water and air pollution.
• Promoting ethical business practices and implementing policies for handling corrupt and unethical dealings.

How ESG investing is measured

The way a company handles ESG issues can be a valuable asset in the decision-making process for stakeholders. There are a variety of tools available for ESG performance that include:

• Global reporting initiative (GRI)

As the first global standard for sustainability reporting, GRI was developed by the Coalition for Environmentally Responsible Economies (CERES) along with the United Nations Environment Programme (UNEP) in 1997 in response to the Exxon Valdez oil spill that took place on March 24, 1989.

Despite the availability of newer reporting tools, GRI is still the most commonly used framework today. Over 80% of the world’s 250 largest companies use GRI, and it’s beneficial to both small and large companies due to its flexibility.

• Carbon Disclosure Project (CDP)

The main objective of CDP is on environmental responsibility and how a company’s business practices impact climate regarding carbon emissions, deforestation, water usage, pollutants, and other environmental concerns.

Companies can disclose their impact on climate through the CDP reporting process, assigning a score based on their transparency. Those scores and data from the CDP can offer an advantage over competitors and are used by investors to evaluate possible investment opportunities.

• The Climate Disclosure Board (CDSB)

The CDSB, like the CDP, the CDSB’s main focus is on collecting and reporting climate and environmental issues. However, although they have similar goals, there are differences as well. For example, the CDP compiles information, whereas the CDSB’s purpose is to incorporate climate change reports into financial reports, such as annual reports and other business filings.

• The Task Force on Climate-Related Disclosures (TCFD)

The TCFD established a set of climate-related disclosures to measure financial risk. These disclosures are voluntary, and for the companies that use them, they can offer a way for investors to evaluate the company and whether or not they provide safeguards against the risks associated with climate change.

• Dow Jones sustainability world index (DJSI)

The DJSI is a world index that includes a variety of stocks within the S&P Global Broad Market Index (BMI). Inclusion is based on long-term practices surrounded by environmental, social, and governance criteria.

Why does this matter? As interest in ESG investing grows, investors require a way to measure a company’s performance and how well it aligns with their values. Due to this, several ESG rating agencies provide data based on how well a company is able to perform in relation to meeting sustainability investing factors. These reports help investors to make informed decisions about investing in companies they care about.

How to get started with ESG investing

Suppose you’re investing as a beginner or are interested in either creating a portfolio or adding to an existing one. In that case, ESG investments aren’t difficult to find and offer plenty of options to choose from. Here’s how you can get started.

Step 1: Be clear on your own values.

To find the right investments for you, understand what you value most, and look for companies representing those beliefs. Not all ESG companies provide the same focus. Some may be geared to environmental issues, while others may prioritize social issues, so knowing what’s important to you can help make the process easier.

Step 2: Nail down your ESG strategy.

With all the information available on ESG investments, you can start your search on your own or use a robo-advisor through your brokerage account to help. To choose them yourself, make it a habit to read up on each company’s environmental, social responsibility, and governing practices, making sure they align with your own values.

Robo-investors also offer options for finding investments within a particular category and can simplify the process based on your investment goals and risk tolerance.

Step 3: Choose how you’ll invest.

ESG Stocks – If there are specific companies you like, investing in their stock can be beneficial to add to your portfolio. In addition, you can review their impact report, which will include information on any environmental or cultural values and details on how they manage those issues.

You may also want to examine any independent reviews and reports to get a well-rounded picture of the company’s values and priorities.

ESG Mutual Funds – Investing in mutual funds is a beneficial way to quickly add diversity to your investment portfolio. ESG funds exist for a variety of companies and, by rounding out investments with companies that have meaning to you, you add diversification and balance to your portfolio while supporting the companies that match your personal values.

ESG Exchange Traded Funds (ETFs) – Investing in ESG ETFs offers a way to combine a variety of sustainable investments.

Benefits and limitations of ESG investing

With more companies paying attention to environmental, social, and governing factors and how they affect their growth, a few benefits stand out, including:

• Improved financials – There’s been a strong interest in ESG companies by investors. More companies realize that they’re not only doing good for the environment and social culture but also improving their own profits because of it.
• Prove leadership – Companies that prioritize ESG factors seem to point out that they are aware of how our changing world and the values represented mean something. By acknowledging that and moving their business practices to align with those changes, more investors will take notice.

Just as there are benefits, some limitations exist, too, including:

• Reporting issues – As updates and changes in regulations are made, many companies may stop reporting, which can alter investment research.
• No universal standards – With various organizations providing their own ESG standards, inconsistencies can occur that may impact investment portfolios.

How to find ESG investments

One way to learn about ESG investment opportunities is to read about various companies in the ESG market to get an idea of what they stand for. Public’s Themes page is a great resource to begin that research.

• Recycling
• Combating carbon
• American made
• Green power
• Woman run companies
• Plant-based companies

The bottom line

As people become more socially and environmentally aware, more investors seek out companies with business practices that align with their values and put their money into those making positive changes.

If you’re learning how to invest in stocks and want to know more about ESG investments, you can find various companies that meet those requirements. When you’re ready to get started on your own investment journey, download the Public app.