What Makes an Investment ESG?
3 min read
Much like the term "thought leader" nearly became a cliche, "ESG" can feel like it's thrown around a lot. However, ESG relates to environmental, social, and governance criteria, meaning it's super important to how modern stockholders invest.
What does it really mean when a public company aligns with ESG?
ESG standards, explained
Multiple sources currently supply ESG standards. Because it's a fairly new investing protocol, there's a lack of standardization. The main companies offering ESG frameworks for companies to follow are GRESB, CDP (formerly the Carbon Disclosure Project), SAM Corporate Sustainability Assessment, and more.
S&P Global bought SAM, which does give more credibility to that framework, though it focuses on the environment over other issues.
Regardless of who's setting the standard, ESG refers to:
Environmental: Working against resource depletion, waste, and biodiversity reduction
Social: Things like labor rights, good working conditions, and diversity, equity, and inclusion
Governance: Things like active corporate governance without corruption
In the UAE markets, ESG plays an integral role. The Abu Dhabi security exchange ADX is part of the United Nations-led initiative Sustainable Stock Exchanges (SSE).
Are ESG and sustainability the same?
Not quite. While environmental sustainability is a big part of ESG, it's not the full picture.
If a company wants to promote sustainability, that's a great strategy to attract younger or newer investors. However, in order to claim ESG standards, there has to be a balance with social and governance considerations.
For example, if a corporation wants to reduce its carbon emissions, it can also increase its starting wage and develop a standard of executive transparency. That's a well-balanced, ESG-focused company.
ESG vs. stock market performance
Many investors wonder whether ESG investments outperform the market. Because ESG investing is so new, it's too early to get a full comparison. Still, the research so far is interesting.
According to S&P Global, "More than half of the environmental, social, and governance-linked funds outperformed the S&P 500 in the first several months of 2021."
When ESG fails
Companies' S-1 filings are getting longer. This means that they're divulging even more information when filing to go public with the SEC. Some of this has to do with brands adding ESG criteria to the prospectus.
This is especially true in the fashion industry, which has been marked for its contribution to waste.
But ESG isn't everything. A lack of standardization can cause different companies to cater to different definitions. Plus, social performance doesn't always move stocks as much as economic performance. We have yet to see the long-term outcome of ESG investing, and US investors could follow different frameworks in the future.
How to incorporate ESG into your investing strategies
Many impact investors use ESG to guide their strategy. If you want to use it, research if a company adheres to ESG standards for the climate, people, and its governance.
You can search a company's annual reports or IPO filings on SEC.gov/EDGAR. You can also screen for ESG on the company's investor relations page.
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