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A Comprehensive Guide to Environmental, Social, and Governance Factors

In recent years, ESG (Environmental, Social, and Governance) investing has not only emerged as a buzzword in the financial world but has established itself as a critical approach for forward-thinking investors.

With global challenges such as climate change, inequality, and corporate governance scandals coming to the forefront, ESG investing offers more than just a financial return; it provides a vision for sustainable growth.

This article delves into the essence of ESG investing, explaining how integrating environmental, social, and governance factors into investment decisions can lead to long-term sustainability and profitability.

What does ESG mean in investing?

ESG stands for Environmental. Social, and Governance. These make up the foundation of critically evaluating investments beyond traditional financial metrics and offer a more intersectional approach which focuses on environmental stewardship, social responsibility, and governance ethics.

  • Environmental criteria assess a company’s ecological impact and sustainability practices.
  • Social considerations explore how a company contributes to social well-being, including employee relations and community engagement.
  • Governance focuses on company leadership, ethical practices, and shareholder rights.
Office building with Trees

Why is everyone investing in ESG?

The momentum behind ESG investing stems from a collective realization of its potential to drive socio-economic progress, mitigate investment risks, and cater to a growing demand for sustainable investment options.

Here are some statistics:

  • The number of Canadian sustainable open-end and exchange-traded funds increased 22% to 32 in 2023, and more than tripled over five years.
  • In 2023 sustainable funds beat their conventional peers by a small margin, with 55% of sustainable funds landing in the top half of their respective categories.
  • Global and international equity funds continue to be sustainable funds’ most popular asset class: 31 of them launched in 2023.

Source: Morningstar Canada Sustainable Funds Landscape:2023 in Review

These numbers don’t lie. ESG is in and is here to stay.

How has ESG evolved?

The concept of ESG investing has its roots in the social investment movements of the 1960s but has significantly evolved over the decades. Originally focusing on the exclusion of stocks involved in controversial activities, it has matured into a proactive approach that integrates ESG factors as core to investment analysis and decision-making processes.

Modern ESG research has now evolved to include some of the following reporting issues: Climate change, the effect of natural resources,  Pollution and waste, on the social side it could include Human Capital, Social opportunities and on the governance side corporate governance, and corporate behaviour, to name a few.

What are existing ESG ratings?

Canada

The Canadian Sustainability Standards Board (CSSB) is set to launch a public consultation to advance the adoption of sustainability disclosure standards in Canada. In March 2024, the CSSB will issue proposals on its first standards, Canadian Sustainability Disclosure Standards (CSDS) 1 and 2, which align with the global baseline standards developed by the International Sustainability Standards Board (ISSB) but with Canadian-specific modifications.

United States of America

The Securities and Exchange Commission (SEC) has recently made a pivotal move by requiring US-listed companies to communicate how they are managing material risks related to climate change and how those risks affect their bottom lines.

These new reporting requirements allow investors more transparency into the threat climate change poses to U.S. publicly listed companies, and how they contribute to a warming planet via emissions.

Europe

The Corporate Sustainability Reporting Directive (CSRD) is a recent EU initiative to institutionalize the sustainability reporting process for companies within its jurisdiction. The advent of CSRD turns a new leaf in the sustainability narrative, helping to standardize data and ensure that we all speak the same language regarding a company’s ecological, social, and governance track record.

This increased transparency plays a crucial role in evaluating financial risks and opportunities, notably those exacerbated by climate change and other sustainability concerns.

These new regulations will affect companies from the 2024 financial year which means that businesses must prepare and adapt for successful compliance in reports published in 2025.

What is the role of rating agencies in ESG?

ESG rating agencies play a pivotal role in the sustainable investing ecosystem by evaluating and scoring companies based on their adherence to ESG criteria. These ratings help investors identify companies that not only show financial promise but also exhibit strong environmental, social, and governance practices.

However, the diversity in rating methodologies and the subjective nature of some ESG assessments raise challenges for investors seeking to compare and interpret these ratings accurately. There is no global consensus or standard that companies adhere to.

As a solution, Shift Critical offers a multidimensional approach to ESG analysis, incorporating various rating agencies’ perspectives to provide a comprehensive view of a company’s ESG performance, enabling informed, nuanced investment decisions.

Green tree pathway

Why is ESG controversial?

Despite its merits, ESG investing faces scrutiny over the accuracy of ESG ratings and the specter of greenwashing.

Shift Critical addresses these concerns head-on with transparent, rigorous ESG analytics, setting a benchmark for clarity and accountability in ESG reporting, thus helping investors navigate the complexities of sustainable investing with confidence.

What are the disadvantages of ESG investing?

While the path of ESG investing is compelling, challenges such as market liquidity and the nuanced balance between ethical considerations and financial returns persist.

Per Manulife, some disadvantages include:

Negative Screening – is an ESG Investing techniques where companies are judged against others in their peer group according to their ESG characteristics. For most investors, negative screening means the avoidance of the lowest-scoring part of an SI metric, usually the bottom 20% stocks ranked on the ESG score. exclude entire sectors, industries, or regies with low ESG scores (e.g., tobacco, oil, Russia, China)

Greenwashing – some corporations and fund managers may be tempted to take advantage of this trend and provide misleading ESG-related information—for example, a fund name that falsely implies a greater degree of ESG integration than there really is. Scrutinizing portfolio managers’ investment processes has thus become even more critical.

Is it worth investing in ESG?

Through its journey from a marginal concept to a cornerstone of investment decision-making, ESG investing reflects a broader shift in societal values towards sustainability and corporate responsibility. Partnering with Shift Critical, investors are equipped with comprehensive ESG insights and analytics, enabling them to be at the forefront of this transformative movement.

As we explore the depth and breadth of what ESG investing entails, it becomes clear that integrating environmental, social, and governance factors is not just about enhancing financial returns but about investing in a sustainable future for all.

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