ESG from the Financial Perspective

When looking at the ESG metric, the environmental aspect often comes to mind. People envision companies and firms implementing changes to reduce emissions and minimize their carbon footprint. However, many investors enter the ESG investing market for the purpose of making money. ESG is more broadly tied to sustainability and is not just limited to the environment.

There are many types of ESG investing that are distinguished by the overall goals and intentions of the investment. Responsible Investing focuses on using ESG factors to mitigate risk and ensure a financial return. Sustainable Investing also revolves around ensuring return, but is slightly more encouraging of long term ESG opportunities and benefits. Impact Investing seeks to create positive environmental or social impacts alongside a financial return. Finally, Ethical Investing involves investing in companies that align with the investor’s personal values. The main idea is that even if investors participating in ESG investing have an ulterior motive of helping to fund an environmental initiative, investors are still looking for a return. But why would investors choose to invest in ESG? ESG investments are often more expensive than their free market counterparts. What are the financial benefits associated with investing with ESG?

To begin, it is important to understand that when a company produces externalities that are highly polluting or socially disruptive, it can lower asset values and reduce returns to investors in the long term. By reducing externalities, a company can avoid damaging profitability and returns. The ESG metric measures the sustainability of a corporation's practices, how efficiently they allocate their capital and minimize external costs. Ultimately, adherence to ESG values is seen to significantly improve the chances of a firm outperforming their counterparts in the long-term. Many investors feel more comfortable and assured when investing in companies involved in ESG and are willing to take on the additional financial cost to make these investments.

ESG is a constantly changing field. Companies must continually account for factors such as disclosure requirements, technological change, demographic shifts, and changes in the distribution of wealth. This is because the different aspects of ESG indicate a well-run and dependable corporation. Common Social values include the health and safety of workers, employee relations (employee retention, engagement, training and development), human rights issues (discrimination, child labor), and cyber and customer security. Common Governance values include diversity, succession planning, risk management, tax responsibility, shareholder rights, and corporate transparency.

In conclusion, companies that score well on ESG metrics are seen to be more likely to anticipate and adapt to risks and take advantage of opportunities in the future and are seen to be a safer investment that will more likely produce returns.