The ABCs of ESG Investing

Increasingly, the acronym ESG may start popping up in materials generated by the mutual fund companies and money managers that handle investments for you, your company and your employees.

ESG, which stands for environmental, social and governance, refers to non-financial elements that may be weighed by investment analysts as they consider where to invest. In fact, in a recent survey, 73 percent of Chartered Financial Analysts—a leading association for such professionals—said that they regularly assess ESG issues, primarily to help manage investment risks.

Sounds useful, right?

Sure. But unfortunately, many money managers leave investors in the dark with regard to how ESG figures into their decision making process, and similarly fail to disclose their spin on ESG analysis.

Therefore, until transparency increases, investors who want to know how if and how ESG analysis is utilized must step up and ask questions.

Arm yourself with the basics

The ESG net is broad with ample room for varied approaches. For example, a fund focused on progressive practices by boards of directors may invest in a oil and gas company, while another fund that emphasizes the environment may invest in a company with lackluster community impact.

Some issues are more prominent than others, and in its biennial report released in late 2014, The Forum for Sustainable and Responsible Investment, a trade association also known as the US SIF Foundation, provided summaries of how to think about E, S and G.

E—Environmental

Probably the most obvious, environmental factors account for a company’s impact on the earth, from its operations to its products, and any resulting ripple effects. Lately, the fossil fuel divestment movement, in which large investors have vowed to sell any holdings tied to resources such as oil and coal, has commanded much of the attention in this space, but money managers may also consider:

• Initiatives to address climate change and reduce carbon usage
• Measures to reduce pollution and minimize exposure to toxic substances
• The development of green buildings, clean technology and renewable energy solutions

S—Social

The largest amount of ESG-influenced investment dollars reside here, where money managers have long shunned countries with oppressive governments, most notably apartheid-tainted South Africa in the 1980s. The lens may also be turned on individual company policies, however, as prominent factors currently considered include:

• Human rights issues, including those specific to countries such as Sudan and Northern Ireland
• Community relations and philanthropic efforts
• Equal employment opportunity laws and diversity initiatives

G—Governance

Among Chartered Financial Analysts, governance matters are the ESG factor most likely integrated into investment analysis or decisions, according to a recent survey. This may stem from the board’s responsibility of representing shareholders, but it could also reflect the accessibility of data that must be publicly reported. Accordingly, key considerations in this area include:

• Board of director issues such as diversity and director independence
• Executive pay
• Corporate political contributions

With any money manager, you have the right to ask what he, she or the investment team is doing with your money when you invest. In turn, if ESG is cited as part of the analysis process, you have the right to ask what ESG analysis is used and how the findings affect investment decisions.