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What is Environmental, Social, and Governance (ESG) Investing?

By: Kaplan Schweser
August 8, 2022
What is Environmental Social and Governance ESG Investing

ESG investing is a framework to help investment firms better understand risks and opportunities associated with a particular company or fund. The framework consists of many ESG factors and uses multiple strategies to make financial projections and assist institutional investment decisions.


ESG Investing Factors

New ESG factors will continue to emerge over time. Currently, many factors are used in ESG investing, but they all get categorized into three groups. 

Environmental Factors

Many environmental factors will sound familiar, for instance, climate change. For example, an ESG analyst could use ESG rating reports along with carbon emission trends to determine if a stock in the energy market is a good investment.

More environmental ESG factors used in ESG investing and analysis include:

  • Deforestation
  • Pollution
  • Green Energy
  • Waste Management
  • Water Usage

Social Factors

Social factors in ESG investing are about the people involved with the organization, either as employees, board members, or customers. For example, ESG analysts could use employee engagement metrics and labor standards in their ESG rating analysis.

More social ESG factors used in ESG investing and analysis include:

  • Employee gender and diversity
  • Data privacy and security
  • Community relations
  • Company sexual harassment policies
  • Workers’ rights

Governance Factors

Governance factors in ESG investing will help investors determine how a company is led and managed. ESG analysts can try to understand how executive incentives are aligned to stakeholder expectations or what types of internal policies exist to encourage transparency and accountability.

More governance factors used in ESG investing and analysis include:

  • Board composition 
  • Corruption
  • Political activities
  • Executive pay
  • Lawsuits
  • Lobbying

Types of ESG Investments

The most commonly used types of ESG investments are stocks and mutual funds; however, ESG investments can be more narrow in scope to support specific causes or technologies. 

ESG Stocks

ESG stocks are simply stocks with strong ESG factors which make them preferable over other stocks. It is the goal of ESG analysis to seek stocks that have high ratings in ESG factors. ESG analysts can use metrics like executive compensation and new data privacy policies to determine if buying the stock is a good investment. 

Investors interested in stocks with strong ESG ratings can check for impact reports from companies. These impact reports may include recent initiatives or future forecasts regarding specific ESG factors which can be used to help make decisions. 

ESG Mutual Funds

ESG mutual funds are investment programs funded by shareholders of companies that focus on ESG factors and have high ESG ratings. Some funds focus on specific ESG issues like renewable energy or human rights. 

Investors interested in ESG mutual funds can find information regarding which companies are invested in a specific fund by examining the mutual fund’s prospectus. A mutual fund prospectus is free of charge and sent upon request to interested investors. 

How ESG Investing Works

ESG investing is the practice of including environmental, social, and governance factors when determining an investment's financial returns and overall impact. 

What are ESG Scores 

An investment's ESG score represents efforts made towards and actual results of specific environmental, social, and governance factors. There are many methodologies and rating systems used across the industry for ESG analysis. 

For example, the largest ESG data provider (MSCI), rates ESG investments on a scale of AAA-CCC, with AAA being the highest rating. Sustainalytics, another ESG data provider, rates ESG investments on a scale of 0-100, with ESG scores above 70 considered “excellent.”

How ESG Scores are Calculated

ESG scores are calculated using various analytical methods all the while using data derived from a company’s publicly available information. ESG rating agencies will use specific ESG metrics like lobbying activities or energy efficiencies. The metrics used can vary depending on who is doing the rating, what market the company or fund is in, and how that company or fund is performing compared to its competitors.

What are ESG Companies?

ESG companies hold strong environmental, social, and governance values while trying to accomplish positive shareholder returns. They can operate in industries such as:

  • Consumer Goods
  • Alternative Energy 
  • Financials
  • Retail
  • Healthcare
  • Technology
  • Transportation

Impact Investing

Impact investing refers to seeking investments that have a positive effect on environmental, social, or governance issues. Investors expect positive outcomes and substantial results when trying to help a business or organization achieve specific goals that benefit the environment or society.

ESG Investing Trends

The importance of environmental, social, and governance issues continues to become a major focus for investment firms. Growth is expected in both using ESG factors to make investment decisions and having data and talent to make solid ESG investment decisions.

ESG issues in new legislation, employment practices, data privacy, environmental implications of technology, and cryptocurrency operations continue to fuel these trends. 

Sustainable,  Responsible, and Impact Investing (SRI) vs. Environmental, Social, and Governance (ESG) Investing

Socially responsible investing (SRI) is the oldest form of ESG analysis, dating back to the 18th Century. In recent years, the acronym has evolved and SRI is now recognized to stand for sustainable, responsible, and impact investing. Both SRI investing and ESG investing involves building sustainable and responsible portfolios, but there are some differences between them.

ESG is noted as the criteria upon which an SRI strategy is developed. An SRI strategy can be defined in many ways, but in general, there are four main types of SRI strategies:

  • Inclusionary
  • Exclusionary
  • Sustainability-themed
  • ESG integration

ESG investing is sometimes referred to as ESG integration, and this is the most commonly used SRI strategy in the United States and other parts of the world. This strategy does not exclude any investments from ESG analysis; it provides a lens to evaluate all companies. ESG typically provides an additional layer of risk analysis, and ethical and impact issues are considered positive benefits. 

Becoming Certified in Sustainable Investing

Becoming educated and certified in sustainable investing is a great way for advisors who wish to specialize in sustainable and responsible investments for their clients. 

What is the CSRIC™ Designation? >>

ESG Investing vs. Impact Investing

Both ESG and impact investing require investors to evaluate similar factors such as pollution or political contributions. Their initial intentions and long-term goals are where they begin to differ. 

ESG investing is the process of including ESG factors and ESG scores to make informed decisions, usually performed by large institutions, about potential profits and new investment opportunities.

Impact investing is the process of investing in companies or funds that align with an investor's or organization's principles with the intention of making a positive contribution to society and or the environment.  

ESG Investing Jobs

There are many jobs that incorporate the use of ESG strategies into their investment decisions. Jobs are prevalent throughout various industries including finance, government, risk management, and energy. 

Individuals can hold job titles such as:

  • ESG Analyst
  • ESG Advisor or Associate
  • Sustainability/ESG Director
  • Director Sustainable Finance
  • ESG Sales & Delivery Manager
  • ESG Program Manager

Certificate in ESG Investing

An ESG certificate can benefit anyone who works in operations, strategy, or management within the institutional investment field. 

An ESG certification can be especially useful for CFA Charterholders, CAIA Charterholders, and Certified FRMs who would like to move into a more senior position and accelerate their careers. Even sales and distribution, wealth managers, product developers, financial advisors, consultants, or risk managers can benefit from improving their understanding of ESG issues.  

Undergraduate and graduate students who are interested in pursuing a career in the investment industry may also benefit from earning an ESG certificate. 

ESG Certificate Guide >>

ESG Investing Course Prep

If you decide to pursue CFA Institute’s ESG Certificate exam, consider making a Kaplan Schweser ESG Certificate prep package—complete with on-demand videos, study tools, and mock exams—the centerpiece of your mission to earn a passing score.

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