Why is Environmental, Social, and Governance (ESG) important for Investors?
Why is Environmental, Social, and Governance (ESG) important for Investors? When you think of investing in the stock market, you probably think about numbers, charts, and financial analysis. While these are all important factors when it comes to profitable investing, there are other factors to consider. Unusual as it may seem, certain companies you might choose to invest in could negatively impact the environment or society if they were to succeed. To account for these factors and their potential impact on your portfolio, investors look at how companies operate from an ESG perspective. This acronym refers to the three main areas where a company’s activities can negatively impact: environmental impact, social responsibility, and company governance.
What is Environmental Impact?
Environmental impact refers to how a company’s activities could negatively affect the world around it. This can take many forms, including air or water pollution, greenhouse gas emissions, or the use of natural resources like water or minerals. Environmental impact is sometimes considered one of the three pillars of ESG, along with social responsibility and governance. However, it’s sometimes treated as its category because the negative effects of poor environmental practices are less dependent on the company’s operations or management style. This means environmental impact can be easily measured and accounted for. For example, environmental impact can be evaluated through a company’s greenhouse gas emissions, carbon footprint, water usage, waste generation, deforestation, and land-use patterns. These measurements can help investors determine how a given company affects the world around it.
What is Social Responsibility?
Social responsibility refers to a company’s obligation to the surrounding society and how it treats its employees, customers, and other stakeholders. Just as environmental impact is a factor that is not directly tied to a company’s operations, the same can be said for social responsibility. Social responsibility can be evaluated through a company’s commitment to diversity and inclusion, philanthropy, and treatment of employees, customers, and suppliers. Once again, these measurements can help investors determine how a given company is impacting society.
What is Governance?
Governance refers to how a company is structured and managed. Generally, governance standards fall across four categories: board structure, executive compensation, director independence, and the company’s use of equity as a financial instrument. So, governance has to do with the rules and regulations that apply to how a company is run.
Why Does ESG Matter in Investing?
When you consider investing in a company, you want to know that it will be profitable. The best way to ensure that you make financially sound investments is to incorporate ESG analysis into your investing strategy. ESG analysis helps investors determine if a company is an excellent fit for their portfolio based on environmental, social, and governance factors. These standards can be applied to nearly every economic sector, from agriculture to technology and healthcare to energy. That makes ESG a useful way to assess a company’s risk profile and determine if it’s an appropriate fit for your portfolio.
How to Incorporate ESG into Your Investment Strategy?
When incorporating ESG into your investment strategy, you must first decide which companies you want to include in your portfolio. Once you have your list, you can use third-party ratings or websites to determine each company’s ESG rating. It’s important to mention that there is no single standard for evaluating ESG, so you will likely have to use several sources to get a clear picture of a given company. Once you have your ratings, compare them to your desired investment criteria. For example, you might want to invest in companies with a certain ESG rating or focus on a sector known for strong ESG ratings. Once you’ve decided which companies to include in your portfolio, you can track their ESG ratings over time to see if they change.
Bottom Line
While it’s useful to keep financial aspects in mind when investing, it’s also important to consider environmental, social, and governance factors. This is because some companies negatively impact the world around them, even if they are profitable businesses. So, while each investor will have criteria for determining which companies to include in a portfolio, it’s important to consider ESG. This will help you avoid investing in companies with negative environmental or social impacts that could harm your portfolio in the long run.