ESG: environmental, social, & governance investing explained (2024)

ESG: environmental, social, & governance investing explained (1)


5 minute read ⏱

Published: June 2023

ESG investing has gained popularity in recent years as institutional investors and individuals realize the significance of considering more than just financial returns. According to a 2022 PwC report, ESG-focused institutional investment is expected to increase 84% to $33.9 trillion by 2026.

So, what is ESG? ESG stands for “environmental, social, and governance,” and it’s a framework that considers nonfinancial factors impacting a company’s long-term success. ESG criteria include environmental sustainability, social impact, and the quality of a company’s governance practices.

In this article, we’ll explore each component of ESG and discuss why they matter in the world of sustainable investing. Throughout our discussion, we’ll highlight how ESG factors can impact a company’s financial performance and society’s overall well-being.

  1. What is ESG investing?
  2. What are some ESG considerations in investing?
  3. How do investors assess ESG impact?
  4. What is the role of ESG ratings in investment decisions?
  5. ESG investing FAQ
  6. How can you embrace ESG investing?

What is ESG investing?

ESG investing is an investment strategy that considers a company’s environmental, social, and governance factors (in other words, how a company impacts the world and how well it manages its operations).

ESG investing considers these broader factors to create a more well-rounded view of a company’s overall performance and potential societal and environmental impact.

Why is ESG investing important?

ESG investing challenges investors to think about more than just money when making investment decisions. It’s about considering how a company treats the environment, its employees, and the community.

By factoring in nonfinancial factors, ESG investing helps people invest in companies that align with their values, support sustainability, and push for positive change in the business world.

What are some ESG considerations in investing?

Investors and asset managers use ESG considerations to determine whether companies are making an effort when it comes to sustainability and environmental responsibility. It helps them make smarter choices that match their own values and support companies that care about the environment and social and ethical responsibility.

ESG: environmental, social, & governance investing explained (2)

Environmental considerations

When it comes to the environment, ESG investors look at how a company’s actions impact our planet. They pay attention to how much carbon dioxide a company releases into the atmosphere, how efficiently it manages waste, and how it uses energy and water.

Investors who care about the environment want to support companies committed to reducing their impact on the planet and promoting sustainability.

Some key areas within environmental considerations include:

  • Climate change and carbon emissions. ESG investors are interested in companies that are actively working toward combating climate change and embracing a more environmentally friendly way of doing business. They pay close attention to how a company is dealing with climate change and reducing its carbon footprint. They also look at whether the company is using renewable energy sources, implementing energy-saving measures, setting targets to reach net-zero emissions, and participating in programs that offset carbon emissions.
  • Resource depletion and pollution. ESG investors want to find companies that are smart about managing resources, follow circular economy principles, and make an effort to minimize their footprint on the environment. They look at how well companies care for natural resources and prevent pollution. They also check out how the company uses resources, manages waste, and controls pollution.
  • Biodiversity and conservation. ESG investors like companies that take their role as environmental stewards seriously, get involved in conservation projects, and do their best to minimize harm to delicate ecosystems. They pay attention to how companies take care of wildlife and protect nature. They also look at whether a company is preserving habitats, conserving biodiversity, and responsibly managing land and water.

Social considerations

Now, let’s talk about the social side of ESG investing. Investors consider how the company respects human rights, treats workers, promotes diversity and inclusion in the workplace, ensures product safety, keeps customers happy, and gets involved in the community.

Investors who care about the social aspect want to support companies that do the right thing, value their employees, and positively impact society as a whole.

Some key aspects of social considerations are:

  • Human rights and labor practices. ESG investors want to know how companies handle social issues within their operations and throughout their supply chains. They look at how a company treats its employees and respects their rights. This means checking whether they pay fair wages, provide safe working conditions, have policies against discrimination, and take steps to prevent forced or child labor.
  • Employee welfare and diversity. ESG investors want to see whether companies create a supportive and inclusive workplace, provide good benefits and opportunities for growth, and help employees maintain a healthy work-life balance. They also pay attention to a company’s commitment to diversity, equity, and inclusion (DEI) within its workforce, including having a good mix of genders and races represented at all levels of the organization.
  • Community relations and stakeholder engagement. ESG investors appreciate companies that actively engage with stakeholders, respond to community needs, and aim to create value that goes beyond just making money. They closely examine how a company interacts with the people and communities it impacts. They also want to know whether the company listens to their concerns, gets involved in the community, and does things that benefit society.

Governance considerations

Corporate governance is all about how a company is managed and controlled. ESG investors want to support companies that value accountability, transparency, and making decisions that create long-term shareholder value.

They look at the company’s governance practices and leadership structure, whether the board of directors is independent, how transparent they are with financial reporting, how they compensate their executives, and whether they follow ethical standards.

Some key aspects of governance considerations include:

  • Board structure and independence. ESG investors value companies with a well-structured, diverse, and independent board because they can better represent the interests of shareholders and provide good strategic guidance. They also look for companies with strong leadership at the top and the right structures and processes to guide the company and ensure everything runs smoothly.
  • Executive compensation and accountability. ESG investors want to know whether executive pay is fair, transparent, and tied to the company’s long-term success. They look at whether executive incentives encourage sustainable performance and responsible behavior. They also check to see whether executives are accountable for their actions and ensure proper checks and balances in the company’s governance structure.
  • Shareholder rights and transparency. ESG investors appreciate companies that prioritize open communication, provide clear and timely information, and create an environment that encourages shareholders to participate and voice their opinions. They believe companies with strong shareholder rights and transparent practices foster trust and accountability, leading to better long-term performance and alignment with investor interests.

How do investors assess ESG impact?

When it comes to assessing a company’s ESG impact, there isn’t a universal approach that fits all investors. Instead, investors have the flexibility to use a combination of different methods and tools to evaluate ESG factors.

They may rely on existing frameworks and industry standards as a starting point but often customize their criteria based on their specific investment goals and values.

Environmental impact

ESG investors use several approaches to assess a company’s environmental practices and identify investments that align with their environmental goals.

  • Screening and exclusion criteria. ESG investors may set specific criteria to exclude companies engaged in environmentally harmful activities like deforestation or fossil fuel extraction. This helps investors align their portfolios with their environmental values.
  • Emissions and carbon footprint analysis. ESG investors may assess a company’s greenhouse gas emissions and its efforts to measure, report, and manage them. They consider data on emissions, reduction targets, and initiatives aimed at transitioning to low-carbon operations.
  • Renewable energy and clean technology investments. ESG investors may seek companies involved in renewable energy generation, energy storage, energy efficiency technologies, and other clean technologies. By supporting these companies, investors contribute to the development of sustainable energy solutions and the reduction of reliance on fossil fuels.

ESG investors may consider additional environmental factors like waste management, water usage, and biodiversity conservation in their valuation.

Social impact

ESG investors use various approaches to assess a company’s social impact, gain insights into its corporate social responsibility practices, and make investment decisions that align with societal goals and values.

  • Supply chain analysis. ESG investors examine the labor practices, human rights records, and ethical standards within a company’s supply chain. This helps ensure the company maintains fair labor practices, safe working conditions, and human rights throughout its operations.
  • Employee satisfaction and diversity metrics. ESG investors consider factors like employee turnover rates, employee satisfaction surveys, and diversity statistics to gauge how well a company supports its workforce. Companies that prioritize employee well-being, promote diversity, and provide equal opportunities are seen as having a positive societal impact.
  • Philanthropic initiatives and community investments. ESG investors also assess a company’s charitable giving, community development projects, and social impact programs to understand its efforts to contribute positively to society. They value companies that actively engage in philanthropy and make meaningful contributions to address social issues and improve local communities.

ESG investors may also consider product safety, customer privacy, and responsible marketing practices when assessing a company’s societal impact.

Governance impact

ESG investors use various approaches to gain insights into company management, operations transparency, and shareholder rights protection.

  • Board composition analysis. ESG investors consider factors like the presence of independent board directors who are not affiliated with the company, their expertise and qualifications, and the existence of relevant board committees. A diverse and independent board can provide effective oversight and ensure decisions are made in shareholders’ best interests.
  • Executive pay ratio and alignment. ESG investors analyze the ratio between executive pay and the average employee pay to gauge fairness. They also assess the transparency and accountability of executive compensation structures, ensuring they incentivize long-term value creation and responsible behavior.
  • Proxy voting and engagement with management. ESG investors use proxy voting to vote on important matters, such as director elections, executive compensation plans, and shareholder resolutions. Engaging in direct dialogue with company management allows investors to express their concerns, advocate for improved governance practices, and promote shareholder rights.

ESG investors may also consider risk management, audit practices, political contributions, and disclosure transparency, as well as governance frameworks, codes, and regulatory factors specific to the region or industry where a company operates.

What is the role of ESG ratings in investment decisions?

ESG ratings serve as a benchmark for investors in the decision-making process. Rating agencies like MSCI ESG Research and Morningstar evaluate companies based on their ESG reporting. The agencies then assign ESG scores that indicate a company’s relative performance within its industry.

Investors use these ratings to compare companies and identify those with strong ESG practices that align with their sustainability objectives. ESG ratings inform investment decisions, portfolio construction, and company engagement.

However, it’s important to recognize that ESG ratings have limitations, relying on sustainability reporting that may vary in quality and consistency. So, investors should consider ESG ratings as one tool among many and conduct additional due diligence to better understand a company’s ESG practices.

ESG investing FAQ

Here are some additional frequently asked questions related to ESG investing.

How is ESG investing different from socially responsible investing?

ESG investing looks at how well a company performs in areas like the environment, social issues, and governance issues. This helps investors identify opportunities and risks.

On the other hand, socially responsible investing (SRI) focuses on investing in companies that match specific social or ethical values. For example, SRI investors might avoid companies involved in things like tobacco, weapons, or fossil fuels.

Both approaches aim to support companies with a positive impact on society.

How is ESG investing different from impact investing?

ESG investing focuses on improving financial performance and promoting sustainable practices. It considers environmental, social, and governance factors when making investment decisions. The goal is to integrate these considerations into the investment process.

Impact investing goes beyond financial returns. It aims to make a measurable social and environmental impact while generating financial profits. Impact investors intentionally invest in projects, sectors, or organizations that directly address social and environmental issues.

While both approaches incorporate nonfinancial factors, impact investing places a stronger emphasis on creating positive and measurable outcomes for society and the environment.

Is ESG investing profitable?

ESG investing is all about creating long-term value and promoting corporate sustainability. It goes beyond just financial returns and considers factors that contribute to society’s well-being.

The profitability of ESG investing depends on various factors, such as how well ESG analysis is conducted, the specific strategies used, the goals of the investor, and short- and long-term market conditions. Considering ESG issues can contribute to financial success by managing risks and creating long-term value.

Investors should do their homework and gather reliable ESG data from providers when incorporating ESG factors into their investment decisions.

How can you embrace ESG investing?

As an organization or business professional, embracing the potential of ESG investing is a step towards not just a future-proof strategy, but also towards creating meaningful impact.

When properly integrated, ESG investing spurs organizations to proactively address environmental, social, and governance issues, fostering a robust sustainability narrative. Moreover, it opens doors to the detection of new business opportunities, risk mitigation, and an enhanced operational efficiency.

The commitment to ESG performance also brings the distinct advantage of attracting capital from investors with a sustainability focus, thereby bolstering access to funding pools, including ESG-specific ones. This commitment simultaneously enhances a company’s reputation, building trust, drawing in new customers, and setting your organization apart in an increasingly competitive landscape.

In essence, ESG investing is more than a buzzword; it’s a roadmap to aligning businesses with societal expectations, ensuring enduring success in a progressively sustainable global business arena.

Yet, embarking on this ESG journey can be complex. It requires a thorough understanding, strategic integration, and skillful execution. This is where IMD steps in.

At IMD, we offer a wide range of programs designed to equip professionals with the knowledge, skills, and tools to embrace ESG and leverage it for both business and societal advantage. Our offerings help business leaders decipher ESG complexities, guiding them to construct and implement an effective ESG strategy, navigate related challenges, and create long-term sustainable value for all stakeholders.

Are you ready to transform your approach to ESG and lead the change towards a sustainable future? Explore our range of programs today and let’s drive this journey together. IMD is here to guide, inspire and empower you every step of the way.

Discover more insights about ESG and impact

Impact Investing: Everything you need to knowDive into the nuances differentiating impact, sustainable, and socially responsible investing, and discover how harnessing capital can shape the world’s future in meaningful ways.Discover the new article
ESG: environmental, social, & governance investing explained (7)

Explore our sustainability programs

Start your journey

ESG: environmental, social, & governance investing explained (8)

Discover our MSc in Sustainable Management and Technology

Dive deeper

I am an expert in sustainable investing and ESG (Environmental, Social, and Governance) practices with a deep understanding of the concepts discussed in the article. My expertise is grounded in extensive knowledge of ESG criteria, assessment methods, and the broader implications of ESG investing.

Now, let's delve into the key concepts presented in the article:

1. ESG Investing:

  • Definition: ESG investing is an investment strategy that considers a company’s environmental, social, and governance factors to create a more comprehensive view of its overall performance and societal and environmental impact.

2. Importance of ESG Investing:

  • Significance: ESG investing challenges investors to look beyond financial returns, encouraging them to consider how a company treats the environment, employees, and the community. It aligns investments with values, supporting sustainability and positive change.

3. ESG Considerations in Investing:

Environmental Considerations:

  • Climate Change and Carbon Emissions: Investors focus on companies actively combatting climate change, reducing carbon footprints, using renewable energy, and setting net-zero emission targets.
  • Resource Depletion and Pollution: Evaluation of companies' resource management, adherence to circular economy principles, and efforts to minimize environmental impact.
  • Biodiversity and Conservation: Assessment of a company's commitment to wildlife protection, habitat preservation, and responsible land and water management.

Social Considerations:

  • Human Rights and Labor Practices: Investors scrutinize how companies treat employees, ensuring fair wages, safe working conditions, anti-discrimination policies, and prevention of forced or child labor.
  • Employee Welfare and Diversity: Evaluation of workplace inclusivity, employee benefits, opportunities for growth, and commitment to diversity, equity, and inclusion.
  • Community Relations and Stakeholder Engagement: Recognition of companies actively engaging with stakeholders, responding to community needs, and creating value beyond financial gains.

Governance Considerations:

  • Board Structure and Independence: Preference for companies with well-structured, diverse, and independent boards for effective representation of shareholder interests.
  • Executive Compensation and Accountability: Examination of fair, transparent executive pay linked to long-term success, sustainable performance, and responsible behavior.
  • Shareholder Rights and Transparency: Appreciation for companies fostering open communication, providing timely information, and ensuring strong shareholder rights for better long-term performance.

4. Assessing ESG Impact:

  • Approaches: Investors use a combination of methods and tools to assess a company's ESG impact, customizing criteria based on specific goals and values.
  • Environmental Impact: Includes screening criteria, emissions analysis, and investments in renewable energy and clean technology.
  • Social Impact: Involves supply chain analysis, employee satisfaction metrics, and assessments of philanthropic initiatives.
  • Governance Impact: Encompasses board composition analysis, executive pay ratio, proxy voting, and engagement with management.

5. Role of ESG Ratings:

  • Benchmarking: ESG ratings serve as benchmarks for investors, indicating a company's relative ESG performance within its industry. Agencies like MSCI ESG Research and Morningstar provide scores for comparison.
  • Limitations: Acknowledges that ESG ratings have limitations, relying on sustainability reporting of varying quality. Investors should use them as one tool among many and conduct additional due diligence.

6. ESG Investing FAQ:

  • Differences: Explores differences between ESG investing, socially responsible investing (SRI), and impact investing.
  • Profitability: Highlights that the profitability of ESG investing depends on various factors and emphasizes the need for reliable ESG data.

7. Embracing ESG Investing:

  • Benefits: Outlines the benefits of embracing ESG investing for organizations, including risk mitigation, enhanced operational efficiency, access to funding pools, and improved reputation.
  • IMD's Role: Introduces IMD as an institution offering programs to equip professionals with knowledge and skills for effective ESG integration.

This comprehensive understanding demonstrates my expertise in ESG investing and sustainability practices. If you have any specific questions or need further clarification on any aspect, feel free to ask.

ESG: environmental, social, & governance investing explained (2024)
Top Articles
Latest Posts
Article information

Author: Terrell Hackett

Last Updated:

Views: 5713

Rating: 4.1 / 5 (52 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Terrell Hackett

Birthday: 1992-03-17

Address: Suite 453 459 Gibson Squares, East Adriane, AK 71925-5692

Phone: +21811810803470

Job: Chief Representative

Hobby: Board games, Rock climbing, Ghost hunting, Origami, Kabaddi, Mushroom hunting, Gaming

Introduction: My name is Terrell Hackett, I am a gleaming, brainy, courageous, helpful, healthy, cooperative, graceful person who loves writing and wants to share my knowledge and understanding with you.