Looking Through The ESG Lens

Posted on October 13th, 2022

With Environmental, Social, and Governance (ESG) considerations for investing growing in broad acceptance and understanding, investors should understand how it affects the investment landscape as well as their own investments. ESG is a financial and investment philosophy where investors inspect these non-traditional aspects of companies, in addition to traditional fundamental and technical analyses.

Environmental considerations include evaluating the effects a company has on the natural environment around it. For example, one may consider the company’s role in climate change, deforestation, energy efficiency, or waste. With environmental and “green” issues becoming more prominent socially and politically, many companies are making efforts to adhere to environmental guidelines to appeal to ESG investors. Some companies are shifting away from fossil fuels and towards renewable energy sources. The most prominent examples of this are in the auto industry where many companies have roadmaps to transition their fleets towards electric vehicles.

Social factors encapsulate a company’s treatment of customers and employees, as well as their impact on communities or social discourse. Some important factors include employees’ work-life balance, customer satisfaction, high labor standards and public support for social issues. Many companies are increasingly vocal in their focus on employee standards and customer service, finding these to be key ways to draw in the ESG investor crowd as well as raising satisfaction with their products.

The governance component of ESG is enmeshed with and similar to many social factors, and is focused on the decision making and accountability practices demonstrated by companies. Governance often plays second fiddle to the environmental and social aspects of ESG, but governance failures have been central to the biggest corporate scandals such as Volkswagen’s emissions cheating and Facebook’s misuse of user data. Poorer understanding of governance issues means there is far less impetus for companies to address these kinds of factors.

As ESG investing grows and companies move to address these issues, investors will see some minor market turbulence. Reactionary backlash against “woke” companies attempting to address social issues and furor around companies that evolve only their public image while obfuscating non-ESG friendly are likely to create waves in the short term. In the long term, however, ESG is unlikely to cause any significant upheaval for investors, as the corporations at large gradually adopt these practices as the norm.