Environmental, social, and governance—also known as ESG—investing is on the rise. In fact, in 2018 nearly one-quarter of all assets under management in the US were invested using some form of ESG methodology, a 44% jump from 2016 levels.

Here is an introductory look at what this accelerating movement is all about.

What Is ESG Investing?

ESG principles sprang from investor efforts to gain insight into corporate behavior beyond what standard financial analysis can provide. Originally, these investors sought to avoid companies that supported war efforts or oppressive government regimes. Gradually, though, ESG analysis came to reflect a less exclusionary philosophy and is now gaining acceptance as an effective way to both gauge financial risk and reflect on a company’s impact on the wider world.

Some core ESG investing factors include:

  • Environmental factors: Companies’ relationships with climate change, natural resources, pollution, and waste.
  • Social factors: Human capital, product liability, and sourcing challenges.
  • Governance factors: Business ethics, compensation practices, the makeup of boards of directors, and tax and accounting matters.

For many, ESG and impact investing are two disciplines that grapple with the perceived distinction between investing for returns and investing based on one’s values. A recent survey found that 7 out of 10 US investors want access to investment vehicles that reflect their personal values and meet ethical requirements—yet almost half say that they’ll avoid such investments if they see potential for lower returns. But as the United Nations’ Fiduciary Duty in the 21st Century concludes, “Integrating ESG issues into investment research and processes will enable investors to make better investment decisions and improve investment performance consistent with their fiduciary duties.”

For many, ESG and impact investing are two disciplines that grapple with the perceived distinction between investing for returns and investing based on one’s values.

How Do Investors Integrate ESG Factors?

Incorporating ESG analysis into investment strategies takes a variety of forms. Some investment managers employ a qualitative approach, such as weighing a number of ESG issues against each other to differentiate between two similar companies. Others weave quantitative ESG data into their fundamental analysis.

Geography plays its own role in determining how to approach ESG investing. Recent research has found that an “ESG momentum” strategy meant to anticipate companies’ potential to improve ESG results is a better fit for portfolios in the US and Japan, where ESG acceptance is gaining traction. Meanwhile, an “ESG tilt” strategy, which emphasizes focusing on companies that are currently reporting robust ESG performance, is more beneficial for investing in Europe, where ESG matters have been prominent for years.

To help move the needle on ESG issues, investors sometimes arm themselves with shareholder engagement strategies, such as proxy voting, that give them a say in how companies address ESG factors. For example, investors might attempt to sway an organization on how it reports diversity statistics or assesses the risks that climate change poses to the bottom line.

Although the CFA Institute reports that the period between 2009 and 2018 was good for ESG stocks, it adds that market dynamics favored companies that tended to post good ESG results—and a market shift away from those characteristics could hurt ESG investors. Such findings will likely add fuel to the ongoing do well vs. do good debate, and it will remind investors about the significance of how ESG insights are used to drive investment decisions.

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