What Is ESG Investing and How to Make Your Portfolio Purposeful

Sustainability, as we know it, has evolved from a mere corporate buzzword into a tangible reality. The people have heard the planet’s constant calls for action, and companies have chosen to act on the same.

Environmental, Social and Governance (better known as ESG) principles refer to a set of practices that guide companies in ensuring their commitment to the environment, making a positive societal impact, along with abiding by set standards in corporate governance.

Socio-Economic Challenges have finally received the attention it always deserved, and society has chosen to act upon the same. Fortunately, investors, too, have recognised the same, and now they prefer to align their investments with their values, thus bringing us the concept of ESG Investing.

ESG Investing has recently gained popularity, and this article seeks to explore how effective implementation of the same can work out in your favour, while ensuring that Mother Nature is protected during and beyond the process. 

This blog will also focus on how you can ensure that your ESG-oriented investments are actually impactful, and it will further explore on why you’re better off investing in ESG in a long-term timeframe.

What is ESG Investing?

ESG Investing is a forward-thinking investment strategy that strongly emphasises a company's performance in 3 key areas: Environmental, Social, and Governance, in addition to traditional financial metrics.

ESG Investing primarily revolves around a comprehensive assessment of the following aspects:

⚫ Environmental Factors: These revolve around the company’s contributions to environmental sustainability measures and practices, such as climate change, reducing carbon footprint, responsible water use, resource conservation efforts, pollutant management, and adoption of clean technology.

⚫ Social Factors: These revolve around the Company’s Social Commitments. It focuses on how the company engages with its employees, suppliers, customers, and the communities in which it operates. The company’s contributions towards Diversity, Equity and Inclusion (DEI) measures, along with its commitment to human rights, labour rights and so on are put into consideration

⚫ Governance Factors: In this realm, an organisation's overall structure, ethical standards, and management practices are assessed. This includes scrutinising aspects like board diversity and independence, executive compensation practices, transparency in financial reporting, anti-corruption policies, protection of shareholder rights, and so on.

ESG Investing effectively aims to create a holistic, well-rounded view of a company’s performance by considering the above-mentioned factors along with traditional financial metrics. Such an approach ensures responsible investing, while also aligning investments with broader socio-environmental goals, thereby making it an influential strategy in today’s economic landscape.

How to assess the impact of your ESG Investments?

Although measuring the impact of ESG Investments can be tricky, it is possible. Harvard Business School Professor Shawn Cole has laid down a few effective assessment methods that can be used to measure ESG impact, all of which come with varying degrees of accuracy and effectiveness -

👉 Randomised Controlled Trials (RCTs) involve randomly assigning a group to an impact initiative and a control group. This method is rather rigorous and is therefore less prone to bias.

👉 The Difference-in-Differences (DiD) method compares a treatment group with a control group and measures the impacts made before and after an ESG Investment. Although efficient, it runs the risk of bias owing to non-random selection of groups.

👉 The Pre-Post Comparison method measures ESG impact by analysing pre- and post-investment data but from a single group. However, results can be skewed by external factors.

👉 Surveys, Anecdotes and Proprietary Views are also methods through which data can be collected on ESG Investment impacts. However, all these methods possess a heavier risk of being inaccurate.

Choosing the appropriate tool for measurement of impact would ultimately boil down to factors like cost-effectiveness, how it aligns with investment goals, and the extent to which the data can be relied upon. The final choice should align with the investor’s objectives and resources.

Beyond these metrics, relying on the proven method of Due Diligence can help by a significant margin. At the beginning of the Investment journey, one can pick out companies or funds that boast strong ESG ratings and demonstrate a genuine commitment to sustainability and responsible practices. 

This can be followed up with a thorough inspection of their annual reports, and other relevant documents such as ESG ratings by external agencies, third-party assessments, and so on.  Ensuring that the company’s ESG ratings comply with what the investor intends to achieve is crucial.

For an independent assessment of your investments' ESG performance, it is recommended to consult ESG ratings and indices like MSCI ESG Ratings, Sustainalytics, or the Dow Jones Sustainability Index. 

Often, companies and funds publish annual reports and impact reports highlighting their ESG initiatives' positive outcomes. These reports must be regularly followed up and verified from the investor’s end, if possible.

Constantly check on your ESG Investments, preferably on a quarterly basis, and analyse their impact and returns. Feel free to make changes if they are underperforming. Shareholders have always possessed significant influence over corporate behavior.

If you end up in a position where you’re doubtful of the impact of your ESG investments, do consider consulting a financial advisor or an advisory firm that can provide you with the expert guidance that you seek.

Why ESG Investments are Better in the Long Run?

ESG investments make perfect sense in a longer timeframe, offering a win-win scenario for the investor, the company, and society.

For the investor, making an ESG investment would imply investing in a company that promotes and abides by what he or she believes in. Moral win aside, companies prioritising ESG generally tend to follow more sustainable practices, ensuring that the investments made will carry over well into the future.

For Businesses, embracing ESG is genuinely the way ahead. With over 1 trillion USD rolling into ESG investments from as late as 2020, the general social trend appears to be in favor of sustainable investments. The large amounts of money that have flown into ESG investments indicate the pulse of the market, and companies almost always succeed by giving the market what it wants.

From a regulatory perspective, investing in ESG-compliant businesses and investment funds appears to be best. India’s lead market regulator, SEBI, has begun to implement ESG compliance regulations, and more regulations are bound to follow.

ESG investing also contributes to the cause of societal benefit. Besides, environmental benefits, the ESG framework also contributes to social and economic transformation. 

For instance, the adoption of the ESG framework by microfinance institutions or MFIs has furthered the financial inclusion of women and the poor in India. MFIs contribute to the ESG framework by financing small and medium-scale sustainable development initiatives and providing financial assistance to women in rural and semi-urban areas. This way, they ensure progress on both the environmental and social fronts.

Providing financial assistance to women entrepreneurs in rural and semi-urban areas contributes to the higher goals of financial inclusion and women empowerment. 

MFIs also provide skill development training to women in rural areas to bolster financial stability. These steps by MFIs, within the ESG framework, will go a long way in strengthening the social system and eradicating of social evils. 

Women's financial stability will also contribute to reducing cases of domestic violence. Additionally, it is likely to spin off a virtuous cycle of education and social upliftment.