12 min read

What You Need to Know About ESG Investing

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ESG investing is a form of sustainable investing that takes into account environmental, social, and governance factors to evaluate an investment’s financial returns and its overall impact. An organization's ESG score measures the sustainability of that organization in the aforementioned areas (environmental, social, and governance). 

What Does ESG Stand For?

ESG stands for Environmental, Social, and Governance. These non-financial factors are increasingly being used by investors as part of their analysis process to spot growth opportunities and material risks. 

ESG criteria measure how companies or investments perform in specific categories. Environmental factors examine how the natural environment is preserved, social factors look into the treatment of people outside and inside the company, and governance factors look at how a company is run.

E - Environmental

A company's use of renewable energy sources, how it tackles potential problems of water or air pollution that arises from its operations, its waste management program, its attitude and actions on climate change issues, and deforestation issues (if applicable) all form part of the environmental criteria. 

Other possible environmental issues are raw material sourcing (for example, does the company use organic ingredients and fair-trade suppliers?) and do the company follow biodiversity practices on land it controls or owns. 

S – Social

The social component of ESG covers a wide range of potential issues. Although there are many different social aspects of ESG, they are all essentially about social relationships. One of the main relationships for a company, from the viewpoint of most socially responsible investors, is its relationship with its employees. 

Some of the social factors considered include working conditions (including slavery and child labor), conflict regions, employee relations and diversity, health and safety, and local communities (including indigenous communities). 

G - Governance

In the context of ESG, governance is basically about how a company is managed by its executive management and the board of directors. How well do they attend to the interest of the company’s various stakeholders, such as employees, shareholders, customers, and suppliers? 

Some of the governance factors considered are executive pay, political lobbying and donations, tax strategy, bribery and corruption, and board diversity and structure. 

You can read about the key differences between SRI, ESG, and impact investing here.

Why Does ESG Matter?

When it comes to why ESG matters, there are two broad schools of thought: one starts with the role of investors in society and the second focuses on risk management. 

The role of investors in society

Many investor groups, including charities and endowment funds, pension funds, see their role as being more than just return-seekers. These investors are conscious that financing societal initiatives, contributing to the cost of education, and funding our retirements, can give them a role within wider society. 

With this level of responsibility comes influence. These investors groups are in charge of significant pools of capital; their ability to direct this capital gives them a considerable amount of authority. They choose how and where they want their funds allocated, and can opt for investments that target a positive effect on the society or those that aim not to have a negative effect. 

Risk management

Investors who follow this approach include ESG factors into their investment process to aid mitigate risk. A potential investment in a company with low ESG standards, for example, could expose the portfolio to several risks faced by the company in the future, such as litigation and negative publicity, worker strikes, resulting in reduced future returns. 

Monitoring an investment's ESG credentials can help investors make smarter risk-based decisions. This approach is an evolution, not a divergence, from the traditional investment principle of maximizing shareholder value. 

The ESG Investing Boom 

ESG investing is growing at an exponential rate as more investors and issuers use ESG and climate data and tools to support their investment decision-making. The boom in ESG investing can be attributed to several factors. Some of these factors are discussed below. 

The world is changing

Global challenges, such as increased regulatory pressures, climate risk, privacy and data security concerns, and social and demographic shifts represent increasing or new risks for investors. 

The economic pressure placed on some industries (such as oil and gas) by the COVID-19 pandemic has affected companies' exposure to ESG risks and their capacity to manage them. If companies do not adequately manage their ESG or climate risk, they will face increasing complexities and greater scrutiny. 

Better data and technology for more relevant insights

Advanced technology, including AI (artificial intelligence) and alternative data extraction techniques, help reduce our reliance on companies’ voluntary disclosure. Machine learning and natural language processing (NLP) help us increase the precision and timeliness of data collection, analysis and confirmation to deliver dynamic content and financially important ESG insights. 

For instance, the LITH Token platform is designed to make ESG investing easier, providing consumers with simplified ESG scores and metrics, as well as enabling companies to track their progress and transparency across the world. 

A new generation of investors

The rapid growth in ESG investment has already been aided by the interest of millennial investors around the world. The interest of these investors is likely going to increase, enhancing further the growth of ESG investing. 

You can read about ESG scores and ratings here.

How to Get Started with ESG Investing

Starting a portfolio and filling it with ESG investments doesn’t have to be difficult. There are more ESG investments than ever before and so, you’ll have plenty of options to choose from. To build an ESG portfolio, you can follow the steps below. 

  1. Choose to do-it-yourself or get some assistance

If you want to build an ESG-style investing portfolio, you must first decide whether you want to do it yourself by selecting specific ESG investments or search for a robo-advisor to do it for you.

You may want to do it yourself if you like the idea of learning about a company’s sustainability initiatives or making sure that a fund’s companies align with your moral compass.  

It takes time to build an investment portfolio, especially when you are looking for investments that align with a specific framework, such as ESG. In such cases, you may need Robo-advisors. They can make it easy for you to find the type of investments you want. 

Robo-advisors are online advisors that build and manage your investment portfolios depending on your risk tolerance and goals. These advisors are usually less expensive than in-person advisors. If you decide to work with a robo-advisor, the rest of the steps below can be ignored. 

You can learn more about robo-advisors here

  1. Know your own ESG policies

Even if ESG has some clear boundaries, especially when compared to “socially responsible investing” or "ethical investment", that doesn't mean it perfectly aligns with your values. 

Values vary from person to person and so, you need to take some time to identify some of your most important values and see if any of them fall outside of what "ESG" encompasses. 

If they do, make sure you're on the lookout for investments that share similar values. Muslim investors, for example, may want to make sure that their investments are compliant with Islamic law.

  1. Find your ESG investments

You may begin building your portfolio once you have a brokerage account and have decided the industries you want to support with your investment dollars. 

Reading reviews from independent research firms like Morningstar can inform you on how a fund or company performs in terms of ESG investing factors, and whether you should invest in them.

You are likely to include the following two kinds of investments when creating your own ESG portfolio: 

  • Individual stocks. Although it's generally a good idea to keep the percentage of your portfolio that’s in individual stocks to a minimum, if you like a particular company (and believe it will perform well over time), you may consider buying its stock. Some companies provide an impact report that details any cultural or sustainable initiatives they've implemented, as well as how they deal with issues like carbon emissions. 
  • Mutual funds. In recent years, the number of ESG funds has increased. Funds can diversify your holdings instantly and can complete your portfolio quickly. Morningstar data showed an increase in open-end and exchange-traded funds from 270 in 2018 to 303 in 2019. Some of these funds are focused on a specific issue like green energy. This makes it easy for you to personalize your portfolio’s area of impact. 
  1. Take advantage of LITH Token platform

Existing ESG rating systems are very inefficient and based on subjective opinions, negatively impacting the rating themselves and the cost of obtaining ratings. However, with LITH Tokens' blockchain-based rating, these negative impacts can be eliminated. 

LITH Token ESG blockchain platform will also make ratings cheaper, faster, and more accessible for all organizations wishing to obtain ratings that are verifiable by independent rating organizations. 

To learn more about how LITH Token can benefit individuals and organizations, check out the project whitepaper here. 

How Can ESG Help Organizations Attract Investors? 

It is essential for organizations to identify and embrace the shift taking place in the investing world. The term "investor" no longer refers solely to a select group of people. Rather, investing is becoming more widely acknowledged as a tool to vote with one’s dollars, drawing a diverse range of people around the globe. 

Investors now examine a far broader range of factors when making decisions, reflecting the gradual diffusion of more holistic and progressive ESG values into the investing arena. Issues such as COVID-19 and climate change have highlighted the need for organizational resiliency, and have demonstrated the vulnerability of business-as-usual approaches. 

To support future generations, stakeholders and shareholders expect a transition to more socially, economically, and environmentally sustainable business activity.  

Organizations can attract investors by building their adaptive capacities. They can do this by considering a progressively wider range of metrics in their operations and long-term strategies. Organizations can set themselves up for success by identifying ESG benchmarks that are material to them and then setting robust targets against these benchmarks. 

Why Should You Choose ESG Investing?

One reason to consider ESG investing is to ensure that your investment choices are in line with your priorities. 

"Many clients are very concerned about social and environmental problems, such as data security and privacy, gender and racial inequality, climate change that leads to more and severe climate crises,” says Zhang of SoFi and Purview Investments. 

These clients want to make sure they aren't investing in firms that worsen or contribute to these problems, preferring instead to invest in those that are actively leading ESG movements.

Reasons why you should choose ESG investing include: 

High returns

Aside from helping fight social injustice and climate change, an ESG investing strategy can also provide higher returns.

Lower risk

A study by the Morgan Stanley Institute for Sustainable Investing showed that sustainable funds consistently had a lower downside risk than traditional funds, irrespective of the asset class.  

According to the study, traditional funds had a considerably higher downside deviation than sustainable funds during turbulent markets, such as in 2018, 2015, 2009, and 2008, implying that sustainable funds had a lesser potential for loss. 

Growth into the future

One of the reasons to consider ESG investing is that it is expected to continue exceptional growth into the future. According to a survey by Blackrock, investors intend to increase their 18 percent share of sustainable investments to 37 percent globally by 2025. 

Additionally, a survey carried out by Brown Brothers Harriman indicates a growing market for ESG ETFs in Greater China. According to the survey, 53 percent of investors expect to have at least 11 percent of their portfolio in ESG ETFs in five years. 

Furthermore, research by pwc forecast that European ESG assets will grow to between €5.5 trillion and €7.6 trillion by 2025, accounting for up to 57 percent of total mutual fund assets in Europe, up from 15.1 percent at the end of 2019.

To Wrap Up

ESG analysis has become an increasingly significant aspect of the investment process. Investors now incorporate ESG data into their investment process to gain a comprehensive understanding of the companies in which they invest. 

Although ESG metrics are not generally part of mandatory financial reporting, companies are proudly making disclosures in their yearly report or a separate sustainability report. Increasingly, there is consensus among many regulators that publicly traded companies will be required to adopt some form of standardized ESG disclosures.  

Numerous institutions, such as the Global Reporting Initiative (GRI), the Task Force on Climate-related Financial Disclosures (TCFD), and the Sustainability Accounting Standards Board (SASB), are working to develop standards and define materiality to expedite the incorporation of ESG factors into the investment process.

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