What is ESG investing?
Environmental, social, and governance (ESG) investing is an approach that evaluates companies not only on traditional financial metrics but also on how they perform on environmental, social and governance issues. ESG investors use those criteria to screen investments, integrate nonfinancial risks into valuation, or pursue measurable social or environmental outcomes alongside (or instead of) financial returns. ESG is sometimes called sustainable investing, responsible investing, impact investing, or socially responsible investing (SRI). (Investopedia)
Key takeaways
– ESG = Environmental, Social, Governance — a set of nonfinancial factors used to evaluate companies. (Investopedia)
– Investors use ESG to screen, integrate, or actively engage with companies; products include ESG ETFs, mutual funds, and bespoke mandates. (Investopedia; Morningstar)
– ESG scoring is provided by data firms (MSCI, Morningstar, Bloomberg, others), but ratings and methodologies vary. (MSCI; Morningstar; Bloomberg)
– ESG has grown rapidly: sustainable funds reached about $3.2 trillion in assets under management globally in Q4 2024. (Morningstar)
– Watch for greenwashing and inconsistent data — ESG is evolving and not yet standardized. (Investopedia; ESG Analytics)
How ESG investing works (overview and common strategies)
Investors apply ESG in several common ways:
1. Negative/exclusionary screening — exclude companies or sectors (e.g., coal, tobacco, weapons, private prisons) that fail moral or risk screens. (Trillium example)
2. Positive/best-in-class screening — select companies with superior ESG performance within a sector.
3. ESG integration — explicitly include ESG risks and opportunities in fundamental analysis and valuation.
4. Thematic investing — invest in themes such as renewable energy, clean technology, or social impact.
5. Impact investing — target measurable social or environmental outcomes alongside financial returns.
6. Active ownership/stewardship — use engagement and proxy voting to influence company behavior.
Who uses ESG and product types
– Institutional investors: pension funds, endowments, insurers increasingly apply ESG to manage long-term risks and align with beneficiaries. (Investopedia)
– Retail investors: through ESG mutual funds, ETFs, and robo-advisor offerings (e.g., Betterment, Wealthfront). (Investopedia)
– Asset managers provide ESG-labelled funds and customized mandates; many large banks publish ESG reports on their activity (e.g., JPMorgan Chase, Goldman Sachs, Wells Fargo). (Goldman Sachs; JPMorgan Chase; Wells Fargo)
ESG metrics — examples and what they measure
Environmental (E)
– Greenhouse gas emissions (Scope 1, 2, sometimes 3)
– Energy efficiency and renewable energy use
– Pollution, waste and water management
– Biodiversity and land use
Social (S)
– Labor practices, employee health & safety, fair wages
– Diversity, equity and inclusion (workforce and board)
– Human rights in supply chains
– Community relations and customer privacy/product safety
Governance (G)
– Board structure and independence
– Executive compensation aligned with performance and ESG goals
– Audit quality, internal controls, and transparency
– Shareholder rights and anti-corruption policies
(For a primer on each pillar: S&P Global and Harvard Law School Forum on Corporate Governance provide in-depth guidance on E, S and G topics.) (S&P Global; Harvard Law School Forum)
Practical steps — How investors can implement an ESG approach
1. Define your objective
– Do you want to avoid harm (negative screen), seek best-in-class companies, pursue impact, or integrate ESG into risk analysis?
2. Choose a strategy and product type
– Passive index-based ESG ETFs, active ESG mutual funds, direct stock picking with ESG integration, or impact/private markets.
3. Check methodology and holdings
– Read fund prospectuses and methodology documents; review top holdings to confirm alignment with stated ESG goals.
4. Compare ratings and providers
– Look at multiple ESG data providers (MSCI, Morningstar, Bloomberg) because scores can differ by methodology.
5. Consider exclusions and engagement
– Decide whether you prefer exclusions (e.g., tobacco, coal) or active stewardship and proxy voting to change company behavior.
6. Monitor performance and impact
– Track both financial returns and ESG KPIs; review periodic stewardship reports and controversies.
7. Beware greenwashing
– Ask for measurable targets, third‑party verification, and transparent reporting. (Investopedia; MSCI; Morningstar)
Practical steps — How companies can build credible ESG practices
1. Conduct a materiality assessment
– Identify which E, S, and G issues are most relevant to your industry, stakeholders, and financial performance.
2. Set measurable targets
– Example: GHG reduction targets (near-term and net-zero timelines), diversity goals, board governance improvements.
3. Build data and measurement systems
– Collect reliable, auditable data (energy use, emissions, workplace incidents, supplier audits).
4. Adopt recognized reporting frameworks
– Consider TCFD (climate), SASB/ISSB (industry materiality & metrics), GRI (sustainability reporting) for consistent disclosure.
5. Strengthen governance
– Ensure board oversight for ESG, link executive incentives where appropriate, and establish internal controls.
6. Engage stakeholders
– Communicate with investors, employees, customers, and communities; disclose progress and setbacks transparently.
7. Use third-party assurance and ratings
– Use verified audits and engage with reputable ESG rating providers to help demonstrate credibility.
(See Trillium Asset Management for an example of integration and exclusions; banks and asset managers’ sustainability reports for corporate disclosure approaches.) (Trillium; Goldman Sachs; Wells Fargo; JPMorgan Chase)
How ESG differs from sustainable investing, SRI, and impact investing
– ESG investing is an umbrella for incorporating environmental, social and governance factors into investment decisions (risk and opportunity lens).
– Sustainable investing often emphasizes investments expected to produce more sustainable outcomes (overlap with ESG).
– Socially responsible investing (SRI) traditionally focused on screening out “sin stocks” and aligning investments with ethical values.
– Impact investing explicitly seeks measurable social or environmental outcomes alongside financial returns.
(Investopedia)
How to know whether an investment is truly ESG — a checklist
1. Read the fund’s prospectus and ESG methodology: does it define criteria clearly?
2. Review holdings: do the top holdings align with the ESG claims?
3. Examine exclusions: are there hard-line exclusions (e.g., >5% revenue from coal) or soft criteria?
4. Check third-party ratings and controversies: compare MSCI, Morningstar, Bloomberg scores and look for news controversies.
5. Look for stewardship and reporting: does the manager disclose proxy voting, engagement activities, and periodic impact reports?
6. Verify targets and outcomes: are there measurable, time-bound ESG targets and third‑party assurance?
7. Understand tradeoffs: evaluate potential sector tilts and long-term performance implications.
(Investopedia; MSCI; Morningstar; Bloomberg)
Important considerations and risks
– No single global standard: ESG data and ratings are inconsistent across providers, making comparisons imperfect. (MSCI; Morningstar; Bloomberg)
– Greenwashing risk: some products use vague or marketing-first claims without substantive practices or measurable outcomes. (ESG Analytics)
– Financial tradeoffs: excluding high-return sectors (e.g., tobacco, defense) can affect portfolio performance or diversification; some investors accept that tradeoff for alignment with values. (Investopedia)
– Measurement limitations: many companies lack robust data (especially on Scope 3 emissions and social outcomes); disclosure can be uneven. (S&P Global; Harvard Law School Forum)
– Evolving regulation: disclosure and reporting requirements are changing in many jurisdictions, which may affect comparability and compliance costs.
The bottom line
ESG investing adds nonfinancial dimensions to investment decisions by evaluating how companies manage environmental impacts, social relationships, and governance practices. It can be applied through screening, integration, thematic and impact strategies, or active stewardship. ESG has become a major force in global markets (sustainable funds reached about $3.2 trillion in AUM in Q4 2024), but the field still faces inconsistent ratings, reporting gaps, and greenwashing risks. Investors and companies improve outcomes by defining clear objectives, using transparent methodologies, relying on multiple data sources, and prioritizing measurable targets and credible disclosure.
Selected sources and further reading
– Investopedia. “Environmental, Social, and Governance (ESG) Criteria.” (primary source content summarized above)
– Morningstar. “Global ESG Fund Flows Increase in Q4.” (Q4 2024 AUM data)
– MSCI. “ESG Ratings.” (coverage and methodology overview; ~17,000 companies as of June 30, 2024)
– Trillium Asset Management. “ESG Integration & Criteria.” (example of exclusions and criteria)
– S&P Global. “Understanding the ‘E’ in ESG.” and “What Is the ‘G’ in ESG?”
– Harvard Law School Forum on Corporate Governance. “Time to Rethink the S in ESG.”
– Goldman Sachs, Wells Fargo, JPMorgan Chase. Corporate sustainability and ESG reporting pages.
– ESG Analytics. “Green, Blue, Pink and Social Corporate Washing.” (analysis of greenwashing risks)
– Bloomberg. “Environmental, Social & Governance (ESG): Bloomberg Professional Solutions.”
If you’d like, I can:
– Walk through selecting an ESG ETF or mutual fund step-by-step based on your goals.
– Create a due-diligence checklist you can use when evaluating ESG funds or corporate reports.
– Draft a one-year ESG implementation plan tailored to a company in a specific industry. Which would be most helpful?