What is ESG Investing?
Environmental, social and governance criteria (ESG) are a set of standards used by companies and investors to measure how a company performs when it comes to stewarding the environment, social relationships, and corporate governance.
Also known as sustainable investing, ESG investing gives socially conscious investors an opportunity to screen potential investment opportunities according to their values.
Some questions an investor might ask when researching companies with ESG policies are:
- What impact does this company have on the environment?
- How does this company improve its social impact, both within the company and in the broader community?
- How does this company’s board and management drive positive change?¹
In addition to asking questions about ESG criteria, there are several strategies investors can use when considering which companies to include in their portfolio.
ESG Investment Strategies
Investment strategies for environmentally or socially conscious investors may include those such as ESG Integration, Exclusionary and Inclusionary Investing, Impact Investing, Socially Responsible Investing (SRI), and Conscious Capitalism.
Investors who use ESG Integration as a strategy for investing consider all environmental, social, and governance aspects when assessing the risk of a potential investment.
Exclusionary Investing involves using ESG benchmarks to weed out companies that do not meet an investor’s sustainability criteria, such as companies that generate revenue from fossil fuels, or tobacco. Exclusionary investing is also called negative screening or negative selection.
Inclusionary Investing, different from “inclusive investing,” is the process of seeking out companies who are intentional about incorporating ESG criteria in their corporate strategy, usually looked at in comparison to their peers in the industry.
Investors who use an Impact Investing approach tend to focus on companies, like renewable energy companies or green technology companies, that aim to create a positive impact on the environment.
Socially Responsible Investing (SRI), like ESG Integration, looks at a company’s environmental, social, and governance policies and procedures to determine whether it is a valid investment. However, investors who use an SRI strategy are more focused on how a company aligns with their own values rather than comparing the company to its peers.
A term that was coined by marketing professor Raj Sisodia and John Mackey, co-founder of Whole Foods, Conscious Capitalism is the idea that companies should focus on upholding ethical standards when it comes to the environment, social responsibility, and corporate governance as they strive to make profits.
For investors who prefer to work with funds or advisors rather than hunt for individual stocks, there are ways to discover ESG funds and ETFs that may provide higher performance returns at a slight premium. An advisor can also help investors find companies that align with their personal values and tailor an ESG strategy to an investor’s individual needs.
Trends in ESG Investing
According to the United Nations 2022 report on climate change, “global net anthropogenic Greenhouse Gas (GHG) emissions during the last decade (2010-2019) were higher than at any previous time in human history.” There is hope that we can reverse some of these changes as countries around the world pledge to reduce carbon emissions. In 2020, emissions dropped by about 5.8% with the onset of the pandemic, stated the report, highlighting that it is possible to cut CO2 emissions from fossil fuel and industrial sources in a relatively short amount of time. However, the global economy still has a long way to go before the net zero emissions goals can be reached and sustained long-term.
What can governments, companies, and policymakers do to combat climate change? The CFA Institute suggests that putting a price on carbon, increasing transparency and disclosure on climate metrics, engaging with companies on the physical and transition risks of climate change, investing in education about climate change, and implementing policies that encourage effort to combat climate change are just some of the ways the industry can make a difference moving forward.²
In addition to the devastating implications of climate change on the future of our planet, the global phenomenon also comes with economic and market implications, with some estimating a US$4.2 trillion NPV cost associated with climate change worldwide by the end of the century, if no action is taken to combat climate change.³ However, with such a drastic transition does not come without risks, and the process will likely need to take many years in order to mitigate the negative effects of such a transition on the economy and markets.
What can investors do to make a difference in the energy transition? First, they must be willing to educate themselves on the economics of climate change, says the CFA Institute. Engaging with companies and policy makers that uphold ESG criteria is also a great way to stay informed on best practices in various industries when it comes to mitigating climate change. However, the CFA Institute also encourages investors to investigate their own climate change scenarios rather than waiting for companies to create and disclose the “perfect” policies.
Inclusion & Diversity
More and more, companies are realizing that incorporating policies on inclusion and diversity is a critical step to demonstrating that they value an inclusive environment that is committed to creating equal opportunity for all. The CFA Institute defines diversity as “the spectrum of human attributes, perspectives, identities, and backgrounds,” and inclusion as “a dynamic state of operating in which any individual or group can be and feel respected, valued, safe, and fully engaged.”⁴ The finance industry is rapidly evolving, the sign of positive change, but there is still much to be done to ensure that ESG standards for inclusion and diversity are met.
What can companies and policy makers do to encourage diversity and inclusion in their ESG strategies? As more and more millennials and members of Gen-Z enter the finance industry (millennials now make up 35% of the labour force), companies must recognize the importance that these generations place on putting their money where it matters, which includes a focus on inclusion and diversity. Corporations need to be aware of potential biases and make policy changes to address them, being intentional about encouraging representation in the workplace at all levels.
ESG Strategy by Industry
Mining undeniably has an impact on the environment, but exploration and mining companies have long been aware of that and have created policies that aim to mitigate the environmental effects of their operations. Many companies have long done this in several ways, including using renewable energy to offset emissions, partnering with and investing in local communities surrounding their operations, and creating intentional governance policies to foster greater accountability with shareholders.
With the increasing popularity of ESG criteria in investing, companies now have the means to create a framework that allows them to communicate how they measure success in terms of stewardship, transparency, and social performance better than ever before.
Steven Walsh, Deloitte Australia Mining & Metals Leader, remarked that “The industry is embracing real opportunities to redefine itself, and to do so faster than many would have predicted a few years ago. Those that succeed in adapting and innovating, will position themselves to lead a Mining industry in a new energy future and leave a positive social impact in their wake.”⁵
As technology becomes ever-more integrated across industries such as energy, infrastructure, real estate, and more, the technology industry presents a huge opportunity for ESG solutions. Even tech companies whose products are not inherently ESG-focused will have to incorporate environmental, social, and governance strategies into their business model to attract the socially-conscious investor of today.
A large focus of the technology industry is infrastructure, and on finding ways to create more environmentally- and socially-friendly solutions to changing infrastructure. Companies like Northstar Clean Technologies, a clean technology company focused on the sustainable recovery and reprocessing of asphalt shingles, are using technological advancements to contribute to a “circular economy” where waste is repurposed and reused rather than discarded in landfills.⁶
A 2021 report from S&P Global notes that technology must and will play “a central role in transforming society through the creation of the digital economy,”⁷ and that the industry needs to begin with leading by example when it comes to ESG.
The energy industry is in the middle of a global shift, as traditional energy companies recognize the importance of integrating ESG strategies and governments and policy makers shift focus to renewable energy. The shift is also driven by consumer demand, with more consumers than ever placing renewable energy at the top of their priority list. Key trends in the renewable energy sector include hydrogen power, electrification, energy storage systems (ESS) technologies, and renewables like solar and wind energy. According to a GlobalData report, the renewable energy market is expected to make up 40% of the global demand by 2030, overtaking power generated by coal by 2024.⁸
However, there is still work to be done to get to those numbers. According to PwC, only 4% of Alberta energy professionals agreed that the government should focus on diversification, 1% said it should develop policies for GHG and carbon trading across Canada, and none supported a national climate policy or stronger ties with Indigenous communities.⁹ However, Canada’s energy sector is getting closer to creating impactful ESG frameworks; most energy and resource companies have already created environmental health and environmental management systems and asset management systems that can be utilized to understand the impacts of a company’s operations on climate change.
Other alternative energy sources such as nuclear energy also provide a way forward to creating a “greener” environment. Not only is mining uranium no more dangerous than other forms of mining, but according to a paper from NASA’s Goddard Institute from 2013, former NASA scientist James Hansen and Pushker Kharecha at the Goddard Institute estimated that the use of nuclear power has prevented nearly 2 million deaths that would have occurred had that power been generated by burning fossil fuels, making it one of the safest forms of energy production.
One way to understand how a company measures its sustainability efforts is by looking at the “triple bottom line,” which is the idea that companies should use ESG to measure their impact rather than only focusing on their profits (the “bottom line”). The triple bottom line looks at three indicators to measure that success: profit, people, and the planet. Using ESG as a tool to screen investments does not mean that investors cannot take financial profitability into account. Rather, the triple bottom line has shown that companies that consider their impact on people and the planet often benefit financially because of their sustainable business practices.
As more companies create policies to integrate ESG criteria into their business strategies, it is now easier than ever for investors to find companies that align with their personal values, across various industries. Whether you choose to work with an ESG fund, an advisor, or to do your own research to find ESG-minded companies to invest in, there are several strategies that will allow you to invest in companies that are making a difference.
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⁶ Northstar Clean Technologies (TSXV: ROOF, OTCQB: ROOOF) is a client of Kin Communications. Kin Communications has not been compensated in any way for the production or dissemination of this article.