ESG: A Short Acronym for a BIG Subject

There is no shortage of acronyms in any industry, including the world of pensions and investments. One of the many acronyms that is commonly talked about, in terms of investments, is a short acronym for a big subject – ESG, which stands for environmental, social and governance.

ESG is an investment consideration that has existed for decades but has gathered more prominence. Reasons for this include: individual investors being more conscious and concerned about the social and environmental impacts of companies they’re invested in, and evidence that suggests investing in companies that manage ESG factors add value for shareholders. It’s important to note ESG by itself is not sufficient enough to evaluate an investment opportunity, but it is a good addition to numerous qualitative and quantitative criteria.

As an individual investing in a pooled investment fund, you do not have control of the investment decision process and as such cannot influence the buy and sell decisions of the fund manager. Some fund managers specifically encompass ESG into their investment philosophy and others may do so less formally – it is very unlikely that any active fund manager would disregard it completely.

Let’s take a brief look at the components of ESG in context to looking at investment opportunities:

Environmental factors look at a company from the perspective of pollution, resource waste or conservation, and animal treatment practices. Logically, a company that is profitable, but risks a significant lawsuit due to environmental damage may face costs that would impact shareholder value or tarnish the brand itself.

Social factors relate to the management of the company’s business relationships (including its employees). Obvious concerns here would be if unsafe or unfair working practices were present, internally and/or externally.

Governance factors include ensuring a company is keeping accurate and transparent standards for employees and shareholders. This also includes controlling possible conflicts of interest that could impact shareholder value. If a company is controlled by a small group of investors, others would want to be assured they have a common alignment of interests for corporate growth and profitability.

As an investor, even though you don’t control the investment selection in the fund, your expectation is that those who are managing your money should have your best interests at heart. This means looking at financial and qualitative criteria, including ESG (either formally or informally). The concept of ESG is not new and is here to stay. In the years ahead you will no doubt hear more about it, as fund managers are increasingly required to provide transparency of their investment selection practices while managing the public perception of the investments they make on behalf of individuals and corporations.