Environmental factors include the contribution a business or government makes to climate change through greenhouse gas emissions, waste management, and energy efficiency. As a result of the renewed efforts, the reduction in emissions has become more important. As a result, the ESG investment, Do you want to know what it is and what types are there? Keep reading!
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What is ESG investing?
The criterion Environment, Social and Governance (ESG) are a set of standards for company operations that are used by socially conscious investors to detect possible investments.
On the one hand, environmental criteria consider how a company behaves in terms of its impact on nature. Second, the social criteria examine how relationships with employees, suppliers, customers and the communities in which it operates are managed. On the other hand, governance concerns the leadership of a company, executive compensation, audits, internal controls and shareholder rights.
It’s the ESG investment is a term often used as a synonym for sustainable investing or socially responsible investing. It is defined as the consideration of environmental, social and governance factors as well as financial factors in the investment decision-making process.
ESG investing is gaining in importance with institutional and individual investors. His practice began in the 1960s as socially responsible investment. Investors have excluded stocks or entire sectors from their portfolios based on their business activities. For example, linked to tobacco production or its participation in the South African diet of the day.
Today, ethical considerations and alignment with values remain common motivations many investors. In fact, the field is growing and changing rapidly as many investors seek to integrate ESG factors into the investment process alongside traditional financial analysis.
Common motivations for ESG investors
As part of the ESG investment, they have been identified three common goals or motivations for investors when considering these types of strategies:
- The integration: Invest by systematically and explicitly integrating ESG risks and opportunities with the aim of improving long-term risk-adjusted returns.
- Values: Invest in the same line as the values and moral beliefs of an organization or an individual.
- Impact: Invest with the intention of supporting positive social or environmental benefits as well as financial performance.
How does ESG investing work?
Investors are increasingly applying these non-financial factors as part of their analysis process to identify significant risks and growth opportunities. ESG measures are rarely included in mandatory financial reports, even though companies are increasingly the subject of disclosures in their annual report or in an independent sustainability report.
As for metrics, there is no standardized approach to calculation or presentation. Investors can use a variety of analytical approaches and data sources to address these considerations. Including customer interest and potential value. Understanding the advantages and limitations of different measures can help build a more complete picture of ESG risks and opportunities.
No company can pass all tests in all categories. Therefore, investors need to decide what is most important to them. On a practical level, investment firms that comply with ESG criteria must also set priorities. However, ESG criteria include avoiding companies exposed to coal mining and those where a certain percentage of their income comes from nuclear power or weapons.
That said, to assess a company on the basis of environmental, social and governance criteria, investors look at a wide range of behaviors:
Environmental criteria may include from energy consumption to waste, pollution, conservation of natural resources and treatment of animals by an organization.
Criteria can also be used to assess the environmental risks a business may face and how it manages those risks. In addition, the environmental risks created by business activities have a real or potential negative impact on air, land, water, ecosystems and human health.
In this sense, the environmental activities of a company considered as ESG factors include the following points:
- Resource management and pollution prevention
- Reduce emissions and climate impact
- Execution of environmental reports or disclosures
Finally, the positive environmental results are as follows:
- Avoid or minimize environmental responsibilities
- Lower the costs
- Increase profitability through energy
- Reduce regulatory, litigation and reputation risks
Social criteria analyze the business relationships of the company. For example, if its suppliers have the same values as the organization, if the company donates a percentage of its profits to its local community, or if it encourages its employees to volunteer there, etc.
Social risks refer to the impact that companies can have on society. They are approached through social activities such as the following:
- Promotion of health and safety
- Promotion of relations between workers and administration
- Protection of human rights
- Focus on product integrity.
On the other hand, positive social outcomes include the following aspects:
- Increase productivity and morale
- Reduce turnover and absenteeism
- Improve brand loyalty
In summary, social criteria include human rights, labor standards supply chain, any exposure to illegal child labor, etc. Also more common issues, such as occupational health and safety compliance. A social score also increases if a business is well integrated into its local community. and therefore has a “social license” to operate with consent.
With respect to governance, investors may want to know if a company uses accurate and transparent accounting methods. On the other hand, for example, if shareholders have the opportunity to vote on important issues.
They may also want reassurance that companies will avoid conflicts of interest when choosing board members. Or if they don’t use political contributions to gain unduly favorable treatment and, of course, they won’t engage in illegal practices.
Governance refers to a set of rules or principles that define the rights, responsibilities and expectations of different stakeholders at the top of companies. A well-defined corporate governance system can be used to balance or align interests among stakeholders. Plus, it can work as a tool to support a company’s long-term strategy.
Governance risks refer to the way companies are run. It addresses areas such as corporate brand independence and diversity, corporate risk management and excessive executive compensation, through corporate governance activities, such as:
- Increase board diversity and accountability
- Protection of shareholders and their rights
- Reports and information disclosure.
On the other hand, the positive outcomes of governance include:
- Align the interests of shareholders and management
- Avoid unpleasant financial surprises.
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