What Are Environmental, Social, and Governance (ESG) Criteria?:
Environmental, social, and governance (ESG) criteria are a set of standards for a company’s action used by socially responsible investors to screen potential investments. Environmental criteria consider how a company safeguards the environment, adding corporate policies called climate change, for example. Social criteria examine how it operates relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
Appropriately, brokerage firms and mutual fund companies have started offering exchange-traded funds (ETFs) and other financial products that follow ESG criteria. Robo-advisors including Betterment and Wealth front have boosted these ESG-themed offerings to younger investors.
ESG criteria are also increasingly informing the investment choices of large organizational investors such as public pension funds. According to the latest report from US SIF Foundation, investors held $17.1 trillion in assets chosen according to ESG criteria at the end of 2019, up from $12 trillion just two years earlier.
Pros and Cons of Environmental, Social, and Governance (ESG) Criteria:
In years past, the social control of investors was assumed to be sacrificing self-interest to some degree by avoiding some investments based on non-financial criteria. Tobacco and defense, two industries avoided by many ESG investors, have historically manufactured well-above-average market returns.
More new, some have argued that moreover to their social value, ESG criteria can help investors avoid the blowups that happen when companies operating in a risky or unethical manner are ultimately held accountable for its consequences. Examples include BP’s (BP) 2010 Gulf of Mexico oil spill and Volkswagen’s emissions scandal, which rocked the companies’ stock prices and cost them billions of dollars.
As ESG-minded business practices gain more traction, investment firms are increasingly tracking their performance. Financial services companies such as JPMorgan Chase (JPM), Wells Fargo (WFC), and Goldman Sachs (GS) have published annual reports that extensively review their ESG approaches and the bottom-line results.
The ultimate value of ESG criteria will depend on whether they encourage companies to drive real change for the common good, or merely check boxes and publish reports. That, in turn, will depend on whether the investment flows follow ESG criteria that are realistic, measurable, and actionable.