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Why Should Investors Consider ESG Companies?

EcologyFinance

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Stephanie Safdie

updated Sep 22, 2023

US Copywriter at Greenly

“ Over time, ESG companies have become more attractive to investors. Interest in ESG investments and the best ESG companies have grown exponentially over the past two decades. As a result, investors have become more savvy about evaluating corporate ESG performance and finding the best ESG company leaders worthy of an ESG investor. ”

Investors are closely watching ESG trends like climate change policy, sustainable consumer demand, and litigation on key issues like sexual harassment to see how well companies have future-proofed their strategy.

This could have a positive outcome for other stakeholders as well, because investors have some of the most influence to persuade companies to measure, report, and improve their ESG impacts – allowing them to qualify for leading financial news while also promoting ethical business practices.

Decades of research has improved the correlation between higher financial performance and ESG ratings, which has attracted more investment than ever to companies with preferred ESG scores.

ESG scores are used to help investors interpret the overall performance on different ESG criteria reported by ESG companies. Financial research companies independently give ESG companies scores based on their proprietary methodologies.

While evaluation strategies and ESG data have improved over time, there are still many gaps and missing information on the ESG companies list. Investors often request additional ESG information to help reduce the inadequacy of data related to ESG performance and ensure they have found the top ESG company leaders to invest in.

Investors tend to take different approaches to evaluating ESG companies. For instance they may pinpoint key issues that comprise an overall ESG strategy, or they may highlight a broad base of stocks with overall high ESG performance.

👉 Whatever their strategy, it's clear that investors are increasingly seeking more ESG information to inform their decisions and ensure the best ESG companies award logo to be distributed are valid.

Reminder: what is ESG?

“ ESG is an acronym that stands for environmental, social, and governance evaluation criteria organizations use to track and measure non-financial performance. ESG data provides a more well-rounded picture of a business's overall strategy and performance than financial returns alone reveal. ”

The catchphrase “triple bottom line” which was coined in the 1990s became a popular way of describing the interconnected importance of the “three Ps”: people, planet, and profit.

All of these elements are part of an overarching corporate social responsibility (CSR) strategy. ESG is also part of this strategy, but it refers more directly to the sustainability metrics and targets that investors evaluate in their ESG investing strategies.

Over time, these values became absorbed in the field of ESG investing, in which investors select their investments using a wide range of criteria that supports sustainable business practices.

Investors are increasingly interested in ESG criteria for evaluating business because higher ESG performance correlates with higher returns, lower risk, and long-term business sustainability.

There are a wide range of issues included in ESG, and many of them have interconnected importance.

Here are some examples:

Environmental: The ways that business operations either deplete or preserve natural resources, wildlife, and the wilderness. Environmental KPIs include greenhouse gas emissions, water use, deforestation, the use of toxic chemicals, and air and water pollution.
Social: How businesses engage with social issues related to human rights, customer satisfaction, diversity, equity, and inclusion (DEI), customer satisfaction, and community engagement.
Governance: The methods, systems, and internal structures in an organization for legally and ethically establishing processes for auditing systems, paying board members, board diversity, fiscal responsibility, fraud and corruption, and taxation.

ESG investing relies on the principles of long-term stakeholder value creation. This is the notion that topics that matter for employees, customers, suppliers, and communities should factor into the value of a company, not just wealth creation for business owners.

“ When businesses report their performance for ESG criteria, it helps investors evaluate a broader range of business activities beyond financial performance. This analysis is both based on existing performance and future targets and trends. Investors can use ESG data to predict a company's long-term viability. ”

Corporations' involvement in ESG includes collecting data, measuring performance, verifying the data with third-party evaluators, reporting to a framework, and communicating their impact.

Why should investors consider ESG companies?

There are several driving forces to the ESG investment trend. ESG investors evaluate ESG performance because it correlates with higher financial performance in various ways, meaning that top ESG companies could reap fiscal rewards.

Let's look at a few of these categories.

Company financials and ESG

A comprehensive study of 2000 ESG performance analyses from 1970 to 2014 looked at the relationship between financial performance and ESG performance across all business sectors and regions.

It found that almost half of companies showed a correlation between higher financial and ESG performance, while just 11 percent of them showed the opposite. The rest showed a neutral correlation.

👉 The study suggested that ESG investment could be a good opportunity for selecting company-level investments, though it may not show the same performance at the portfolio level.

The impact of positive ESG filtering

In a study of 157 best in class companies for ESG performance, selecting investments from ESG criteria reduced volatility and improved returns.

Some sectors–food & beverage and energy–showed even more financial out performance than others. The study covered 12 industries total, and of these, 8 showed both higher returns and reduced volatility with ESG performance filtering. The exceptions were banks, insurance, durables, and automobiles.

“ This study and investing research contradicts an assumption that higher risk may bring higher returns – further demonstrating how committing to impact investing research and ESG focus could be beneficial not only for ESG reporting and ethical and social responsibility, but for those seeking financial success. ”

Financial performance and ESG

Regional differences in ESG performance may also make the financial gains of ESG actors more significant in emerging markets.

Studies show that there is a higher link between ESG performance and financial performance in emerging markets than developed markets. One reason is that implementing ESG is less common in these regions, so it can bring more gain relative to other companies.

For instance, in Asia, ESG breaks the mold of family business models that do not face investment risk from poor financial performance due to their long-standing history and societal positions.

What is an ESG score?

“ ESG investment research firms score companies based on their ESG performance. Oftentimes, they use a set of different criteria to establish overall scores on environmental, social, and governance performance and recognizes companies commitment to ESG factors. ”

Similar to a credit rating, the ESG score is a single indicator which communicates overall performance across different ESG topics.

👉 The aim of research firms is to simplify ESG investing by analyzing all of the ESG data included in a company's annual ESG reports, corporate sustainability initiatives, management decisions, board structures, and other data. They condense this into a score that aids quick comparisons.

ESG scores are both used internally by an organization to strategize ways to improve its score. It is also used externally to communicate to investors and the broader public a company's ESG value.

However, ESG scores do not adhere to a single, standardized methodology. They also do not always represent specific anticipated corporate activities that are often associated with ESG. This is because the overall score synthesizes very diverse criteria into one indicator of performance.

As a result, a company may have poor environmental performance, but still gain a relatively high score based on its governance and social policies. Similarly, if a company doesn't track and measure its ESG performance, it will not receive public credit until it begins to publish annual ESG reports.

For these reasons, ESG scoring is not an exact science with full participation from all market actors. However, they are useful for promoting greater participation, due to the beneficial responses companies receive from investors based on their ESG performance.

An ESG score can also spark deeper consideration of an ESG strategy by board members.

👉 A score can offer a quick reality check of an organization's ESG processes, targets, and strategy.

Selecting targets that are most material to the organization will improve the validity of an ESG score, for instance.

Companies can use the score to prioritize key ESG opportunities and risks on a sector and regional basis. They can also use it to reflect core elements of business that resonate with customers, employees, and the communities where businesses operate.

“ Overall, ESG scores have value for allowing investors to quickly class different companies in relation to their score. However, the scores may require further investigation to understand the precise ESG impact they represent within a company. ”

How is an ESG score calculated?

Each investment research firm has its own weights and scoring guidelines for evaluating ESG performance. The majority of them assign a score out of 100 points. A higher score represents better ESG performance.

Examples of popular research firms for ESG include Bloomberg, the S&P and Dow Jones Indices, JUST Capital, MSCI, and Refinitiv.

👉 One of the primary challenges in the ESG space is ensuring complete, consistent, and comparable data across the ESG scoring factors. On the one hand, companies don't always report enough data. On the other hand, self-reported data is often difficult to verify.

For some ESG issues, third-party evaluators have established systems of review to improve the validity of companies' claims.

Most companies self-report their ESG criteria using a wide variety of methodologies. This skews the data, making it hard to draw reliable comparisons across sectors and regions.

To address these issues, more countries are adopting mandatory reporting directives on key issues like data privacy, climate-related financial risk, and supply chain human rights issues. Frameworks for voluntary reporting are also beginning to align their frameworks to improve consistency.

“ The benefit of improving ESG data and scoring methods to support more accurate comparisons is to drive more ESG action. As investors channel their financial resources towards companies with stronger values-alignment, companies will likely respond to their demand for sustainable business. ”

How can you find your future ESG investments?

Creating an ESG strategy is getting easier now that more ESG data is available than ever. Investors take a variety of approaches to develop a tailored ESG investment strategy.

DIY Research on ESG Stocks and Funds

There are two main ways to invest in ESG stocks without professional advice for your personal portfolio. The first is to research the ESG of the individual stocks you're interested in. A good place to start is looking for the “best-of” lists published each year.

👉 CDP's A-list, Corporate Knights' Global 100, and Just Capital's JUST 100 are several of the many lists which rank companies by their ESG performance.

An easier way to select stocks based on a specific ESG strategy is to identify an ETF or mutual fund that aligns with your specific investing goals. For instance, Blackrock, MSCI, Vanguard, and Invesco all have their own indexes tracking ETF stocks.

To get more detail, the As You Sow app provides targeted information on specific issues like climate change and social justice, so you can align your investments with specific values.

ESG Robo-Advisers

A wide-range of robo-advisors are available for ESG investing guidance for ESG companies. This approach is better for people wishing to rely more on professional advice than hand-picking their portfolios. It offers a middle of the road pay grade that can give professional advice for slightly higher fees than a DIY approach.

Some of the most popular robo-advisers offering ESG-related services are Betterment, Ellevest, Wealthsimple, Sustainfolio, Earthfolio, and OpenInvest.

With their guidance, you can opt for a professional approach to investing, even though you'll end up with investments you could likely access on your own.

ESG Financial Advisers

Financial advisers help you target specific investment strategies to match your lifestyle and long-term priorities. Financial advisers can help you identify opportunities for aligning your unique ESG values with your investment strategy.

Most financial advisers today have working knowledge of various ESG investing opportunities available. You can also search for financial advisers specializing in this area.

Financial advisers cost more than DIY research and robo-advisers, but the service is a more relationship-driven boutique service with premium support and individually tailored advice. This could prove indispensable for ESG companies.

What about Greenly?

Greenly helps ESG companies improve their carbon emissions footprint. By outsourcing your carbon management to Greenly, you can more efficiently report and reduce your greenhouse gas emissions. We offer a range of emissions-reducing strategies to help you achieve your environmental targets.

With a simple, easy-to-use platform and process our team will help you make steps to communicate your commitment to climate action. Get started today.