Investing > ESG Investing Explained

ESG Investing Explained

ESG investing seeks to combine the profit motive with our ethics and moral values—but is it the real deal or just a fad?

By
Reviewed by
Updated January 06, 2022

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

Wouldn’t it be great if you could invest in a business or a fund without any guilty conscience whatsoever?

Sure, Nestle, Coke, and Amazon make great products or offer great services—and they net you great returns if you buy their shares. But somewhere deep down (or maybe not that deep down), you know they could be into some pretty devious stuff. 🤷‍♂️

Making money without sacrificing our values along the way is difficult. But it isn’t impossible—just in Q1 of 2021 ESG funds have grown by $21 billion. This is where ethical investing comes in, and today, we’ll be covering the most widespread of all ethical investing methods—ESG investing. ESG investing is short for Environmental, Social, and corporate Governance. These are the factors that ESG investing looks at when deciding where to invest money—how a business treats the environment, its workers and associates, and society at large.

There is a wide variety of ESG factors to consider. The easiest method is to invest in ESG funds—mutual funds and ETFs purpose-made to fit these criteria of sustainability and ethics. There are also plenty of rating agencies that score businesses with regard to ESG factors.

So, is this the real deal, or just some fad? ESG investing is a legitimate method to grow wealth. You’ll still have to dig deeper, do some research on your own, and compare and contrast scores from different rating sources.

Ready to learn more? Let’s dive in! 🚀

What you’ll learn
  • ESG Definition
  • What Does ESG Stand For?
  • How ESG Scoring Works
  • Reasons To Choose ESG
  • How to Find the Best ESG Investments
  • Alternatives To ESG
  • How to Start ESG Investing
  • Conclusion
  • FAQs
  • Get Started with a Stock Broker

What is ESG Investing 📚

ESG investing is a form of investing that looks at the sustainability of a company with regard to environmental, social, and corporate governance factors as well as profit when deciding what to invest in.

ESG investing depends on independent ratings that explain how a business treats its employees, does it ethically source its materials, how it treats women, and how the company plans to reduce greenhouse gas emissions, as well as many other factors.

The idea behind ESG investing is simple—make your morals line up with your money. And this is nothing new—the history of socially responsible investing, in general, begins with Quakers in North America and Methodists in Great Britain. 

The Quakers prohibited their members from participating in the slave trade, while Methodists pioneered the idea of not investing in “Sin stocks”—alcohol, tobacco, weapons, or businesses that are detrimental to the health of their employees such as chemical production.

So, ESG investing is nothing new—just an evolution of an old idea. However, it has shown quite a lot of progress in recent years—and the ESG market could hit $53 trillion by 2025—an entire third of global assets under management.

Projected growth of ESG investments
ESG is already outperforming many traditional investing approaches and is predicted to skyrocket in popularity over the next decade.

But ESG investing isn’t simply the idea of adding morality to businesses—one of the bonuses of looking at a company in such a holistic way is that it allows investors to better gauge risk. If you know a company isn’t likely to face scandals, lawsuits, or bad press, then it is a much safer investment.

And if you think about it, it makes sense—the environmental and social impact that a business has, together with its corporate governance, has a huge effect on whether or not a business will be successful.

What Does ESG Stand For 🙋

So, as we’ve said before, ESG stands for environmental, social, and corporate governance—however, that’s putting it in broad terms. What you should actually be interested in are the concrete issues that ESG investing looks at—so we’re going to give you a couple of examples.

Environmental Criteria 🌲

How a business handles the effects it has on the environment has become a hot-button issue for many investors. In fact, the so-called “green economy” has a market cap of $4 trillion—and it’s only going to get bigger.

In ESG investing, environmental criteria include things like:

  • ☑️ Greenhouse gas emissions and plans to reduce them
  • ☑️ Responsible and sustainable water usage
  • ☑️ Recycling, upcycling, and disposal of waste
  • ☑️ Effects of air pollution
  • ☑️ Effects on biodiversity
  • ☑️ Effects on deforestation
  • ☑️ Treatment of animals
  • ☑️ Energy efficiency

It’s clear that the E in ESG mainly deals with how sustainable a business is with regard to the natural world around us. Not only is this a key factor to consider in the long-term prospects of a business, but it is also an area that is under a lot of public scrutiny as of late—businesses that don’t do anything to mitigate the harmful effects that they have on the environment are subject to a lot of bad press, and that’s bad news for shareholders.

Social Criteria 🤝

The S in ESG deals with social criteria—how a business deals with its employees, consumers, customers, and consumers. For example, although it might be a veritable giant, Amazon’s struggles with its workforce have led to a lot of backlash—and this might lead to reduced share price down the line. 

Some of the social criteria that ESG investing looks at are:

  • ☑️ Diversity in hiring, salary increases, and promotions
  • ☑️ Treatment of employees
  • ☑️ Employee training
  • ☑️ Customer service
  • ☑️ Employee turnover
  • ☑️ Employee engagement
  • ☑️ Fairness of employee compensation
  • ☑️ Employee benefits
  • ☑️ Prevention of sexual harassment
  • ☑️ Employee education programs
  • ☑️ The public stance of the business regarding political issues and human rights

Once again, we’re dealing with the same set of facts here—these criteria are important for the long-term health of a business, as well as for public relations. Including these social criteria in your investment strategies will help you find businesses that will weather the long-term.

💡 Keep in mind: A company that works on improving relationships with its workforce and the society it operates in has a good chance of increasing its stock price by becoming more appealing to the public.

Corporate Governance Criteria 👔

The G in ESG stands for corporate governance—how a business deals with ethics, the independence of its board, transparency, and its relationship with regulatory bodies.

Some of the corporate governance criteria that ESG investing looks at are:

  • ☑️ The composition of the board regarding diversity and inclusion
  • ☑️ Incidents regarding bribery and corruption
  • ☑️ Lobbying
  • ☑️ Political contributions
  • ☑️ The compensations and bonuses of executives
  • ☑️ Potential conflicts of interest in the board of directors
  • ☑️ The ability of shareholders to nominate board members
  • ☑️ Relationship with the SEC and other regulatory bodies
  • ☑️ Board members’ term lengths
  • ☑️ How ethical the businesses practices of a company are

These factors are the ones that might interest you the most as a potential shareholder—seeing as how plenty of them deal with how a company engages with its shareholders. Most of the other factors are focused on ensuring ethical business practices and avoiding conflict of interest—something that you definitely want to see in a business that you’re investing in.

How ESG Scoring Works ⚙️

ESG scores are made by third parties—companies or institutions that specialize in analyzing how a business deals with these issues. ESG scores are important because while every business is trying to improve in these areas, those that are doing it faster and better stand a much better chance of thriving in the future.

This image lists and illustrates the main factors considered in ESG scoring.
A simplified version of the numerous factors used in ESG scoring.

A lot of metrics go into calculating an ESG score. It’s impossible to mention all of them here, and the metrics that are used differ from ESG scorer to ESG scorer—but almost all of them include carbon emissions, pollution, waste disposal, renewable energy, the company’s supply chain, human rights, shareholders rights, executive compensation, risk, and crisis management, gender equality, tax strategy, privacy protection, board structure, fair compensation and pay,

What is a Good ESG Score? 🧮

What constitutes a good ESG score will depend on who does the scoring. Bloomberg, for example, has a rating scale from 1 to 100. So does Corporate Knights Global. On the other hand, the Dow Jones Sustainability Index (DJSI) has a rating scale of 1—100 but also ranks companies against other companies in the same industry.

ISS, which only deals with corporate governance, has a ranking system that goes from the 1st to the 10th decile. MSCI has a ranking system that uses letters (AAA to CCC). RepRisk also uses a system of letter ranks (AAA to D), while Sustainalytics has a rating scale from 1 to 100, along with sector and industry-based comparisons. Refinitiv also uses a scale of 1 to 100, with each quartile representing poor, moderate, above average, and excellent performance.

Of course, all of these ESG-score providers use different methodologies. If you really want to make sure that you’re investing in a business that is doing its best to protect the environment, take a meaningful stand on social issues, and do business ethically, you’re going to have to take a closer look at what methodology the providers use.

Why Choose ESG Investing? 🤔

The moral and ethical case for ESG investing is clear—however, at the end of the day, we’re all in it for the money. Even though ESG investing has a noble goal, it is also beneficial when looking at the bottom line—profits.

Not only is following ESG factors good for the long-term health and prospects of a business—but the results of adhering to those guidelines are already apparent. Research from Morgan Stanley has shown that sustainable equity funds outperformed traditional funds by a median of 4.3%.

But there’s more data to back this up—S&P Global Market Intelligence data tracked the performance of 27 ESG funds—16 of those outperformed the S&P 500. In the timeframe that was tracked, the S&P 500 rose by 10.8%—and the 16 ESG funds rose between 11% and a whopping 29.3%.

ESG funds
Many ESG funds outperformed the S&P 500 in 2020 and 2021. Image by TradingView.

But not only are ESG-based investments showing good growth—the ESG “industry” itself is showing signs of a rapid expansion. Due to the millennial generation entering the market en-masse, 2020 saw $51.1 billion invested in ESG funds

A third of millennials often or exclusively look at ESG factors when deciding to invest, and research from Morningstar has shown that 72% of the U.S. population has shown at least a moderate interest in sustainability when investing.

Limitations of ESG Investing 🚧

One of the main pitfalls of ESG investing is that there isn’t a single, unifying standard by which companies are measured—instead, every rating agency uses its own methodology. Some agencies focus more on environmental issues, others on social, and some on corporate governance issues—so the bias in the methodology of the rating agencies themselves should be taken into account.

Secondly, international standards differ—a company doing business abroad may fulfill all criteria that the local government asks of them regarding pollution—but if the law is lax, then even though everything seems fine on paper, the spirit of ESG investing isn’t fulfilled.

To give things further context, corporate sustainability disclosures, which are very important for getting an ESG score, mostly rely on having policies in place. But, as you well know, having a policy in place without actually going through with it means nothing—and that’s often the case. Having a relevant policy in place isn’t enough—you have to practice what you preach.

ESG scores are useful tools—but you need to take a close, individual look at companies that you’re investing in. For example, Volkswagen’s emission scandal happened during a time when ESG ratings were favorable and even showing improvement for that company.

How to Find the Best ESG Investments 🕵️‍♂️

When it comes to picking ESG investments, you can either invest in a fund or pick and choose your own stocks. Now, picking and choosing your own stocks is a bit more time-consuming, but it also allows you to craft a portfolio that you can be absolutely certain in, knowing that it aligns with your morals.

If you choose to hand-pick stocks, tools like the S&P Global score screener or MSCI’s corporate search tool allow you to easily see a company’s ESG score. As always when hand-picking stocks, you’re going to need a good knowledge of stock research—how to find and evaluate a company via fundamental analysis and determine its long-term prospects. On the other hand, investing in ETFs or mutual funds is a bit easier.

When it comes to funds, the easiest way to sift through the huge amount of ESG funds on the market is unquestionably Morningstar’s ESG screener. It allows you to sort investments through various filters—including location, allocation, market cap, and asset type, along with filters for sustainability ratings and carbon emissions. 

Smiling girl with headphones looking at phone
A crucial step in choosing an ESG investment is checking the company’s ESG score.

Similar functionality is offered by MSCI’s ESG Fund screener. Remember, you’ll always want to check every available source on a company before investing, seeing as how ESG ratings depend a lot on methodology. 

If you decide to invest in funds, make sure to take notice of the fund’s past performance, as well as the fund’s expense ratio. And we’d recommend that you invest in funds—they’re well-diversified, offer above-average returns when compared to the stock market, and they’re much less of a hassle to invest in. For most investors interested in ESG, ETFs and mutual funds are the way to go.

ESG Investing Alternatives 🗃

Alright, we’ve talked a lot about ESG—you more or less have the basics locked down by now. But ESG isn’t the only approach to ethical investing—there are alternatives. Let’s take a look at some other approaches, and how they differ from ESG investing.

Socially-Responsible Investing vs. ESG 🧑‍🤝‍🧑

Socially responsible investing is a strategy that is used to avoid investing in businesses that don’t match the investor’s morals or ethics, or businesses that are harmful. While SRI uses many of the same metrics as ESG does, the difference is that SRI is mostly exclusionary—it’s all about harm reduction by not investing in harmful businesses.

For example, most SRI investors avoid businesses that are involved with alcohol, gambling, tobacco, weapons, addictive substances, as well as businesses that have poor track records regarding human rights, labor rights, and environmental damage.

When that order of business is taken care of, you’re free to go about positive screening—finding businesses that have practices that you condone, or those that have signed certain principles or have a concrete mission. There’s a lot of overlap between socially responsible investing and ESG—but that doesn’t mean that you have to choose one or another.

Impact Investing vs. ESG 📈

Impact investing is another subset of ethical investing. It is being spearheaded by the Rockefeller Foundation through the Global Impact Investing Network (GIIN).

So, what sets impact investing apart from ESG? The GIIN defines the core characteristics of impact investing, which are:

  • ☑️ Intentionality—clear and stated intention to generate positive change
  • ☑️ Investment with return expectations—these investments are still meant to generate profits
  • ☑️ Range of return expectations and asset classes—impact investing utilizes various asset classes
  • ☑️ Impact measurement—measuring, reporting, and improving on the positive changes that a business generates

In order to achieve this, impact investing uses a much wider range of metrics—the GIIN’s IRIS catalog of metrics. Businesses have to report on the changes they generate and commit to improving in the future in order to attract the attention of impact investors.

Impact investing, however, is still largely a game for high-net-worth individuals. The size of the market is estimated to be $715 billion—and like all other forms of SRI, it is also experiencing tremendous growth. Although ESG investing and SRI are much more accessible, this doesn’t mean that you should rule out impact investing.

Conscious Capitalism vs. ESG 💸

While ESG refers to concrete factors and metrics, conscious capitalism is more of an idea or philosophy that underpins ESG investing and all other forms of socially responsible investing.

While the idea that capitalism can work together with morals and ethics for positive change without sacrificing profits is nothing new, the latest wave of conscious capitalism was inspired by John Mackey, co-founder, and co-CEO of Whole Foods, and marketing professor Raj Sisodia in their book Conscious Capitalism: Liberating the Heroic Spirit of Business.

Smiling young man looking at  laptop
Some experts claim that capitalism and ethics can work together without sacrificing profits.

Their book argues that ethical business means serving all stakeholders equally—including employees, the environment, humanity at large, as well as management and shareholders. The guiding principles of conscious capitalism are conscious leadership, conscious culture, stakeholder orientation, and a higher purpose.

Since the publishing of the book, the two authors have founded a nonprofit organization that has chapters in 10 different countries and two dozen cities in the U.S. The organization seeks to introduce a new way of thinking—one in which free-market capitalism is hybridized with trust, compassion, and collaboration.

Shareholder Activism 🌊

Shareholder activism refers to activities by shareholders designed to bring about change within a company. Although it has largely been the territory of high-net-worth individuals such as famous shareholder activists like Carl Icahn and Bill Ackman, recently, hedge funds have started to push for greater adoption of ESG factors.

Shareholder activism can take on many forms—shareholder resolution, publicity campaigns, negotiation with management, and even litigation. So, what does all of this mean for the little guy?

Unfortunately, not very much. This is still largely a game for those with high net worths. However, with the advent of social media, we might soon come to see an organic sort of activism appear among investors who would like to see more corporate responsibility. 

How to Start ESG Investing 👷‍♂️

If you want to start ESG investing, the first few steps are rather simple. First of all, you’re going to need to find a good stock broker. The usual criteria apply here—what’s the minimum deposit, what are the fees like, is the customer service responsive, etc.—however, you’re also going to want to find out if a brokerage offers good access to ESG funds. Additionally, you should also consider opening an account with a robo advisor.

Now, you can pick your own stocks based on ESG criteria—but it’s a hassle, and not having access to ESG funds puts a huge dent in how efficiently you can support positive change with your investments.

Once you’ve found a broker that matches your criteria, you still have to lay the groundwork. Investing a lot of money at once usually isn’t a wise decision—so we suggest setting aside an amount of money that you’ll invest each month—no matter the market conditions.

After you’ve settled on a budget, it might be time for some soul searching. Although ESG criteria are broad, and methodology varies by rating agency, you should still ask yourself—what are the causes that are nearest and dearest to my heart?

Perhaps you’re passionate about the environment, or maybe workers’ rights, or you care about inclusion—whatever the case, you should definitely have a firm grasp of what your priorities are, ethics-wise before you begin investing.

Once all of that is taken care of, all that’s left to do is to select the stocks that you’ll invest in, if you choose to go that route, or which funds to invest in—along with all the usual stock research and comparing expense ratios.

The Evolution of ESG Investing 🧬

ESG investing is experiencing rapid growth. As millennials enter the investing world in droves, the amount of money that is being put into ESG funds is rising at an exponential rate. In fact, the amount of money invested in ESG funds more than doubled from 2019 to 2020. Research from Deloitte shows that ESG-mandated assets in the United States could grow at three times the rate of non-ESG assets.

On top of that, the ESG market is predicted to experience a compound annual growth rate of 16% in the next five years, which is remarkably fast growth. To put that into perspective, at this rate, ESG-mandated assets could make up as much as half of all managed assets in the United States by 2025. 

Comparing SUSA and SPY
One of the oldest ESG funds, SUSA keeping pace and outperforming the S&P 500.

Some policy changes in the first half of 2021 are also making it likely that ESG funds are going to become even more popular. For example, the Biden administration Department of Labor made it easier to invest in ESG funds in a 401k in March of 2021.

Of course, ESG investing isn’t without its flaws and drawbacks. We’re still in the early days of this phenomenon—and the criteria used to measure positive change are still not perfect and standardized. Greenwashing is still a problem—with many companies using the veneer of sustainability to generate a positive image while doing little in the way of actual progress.

However, the ball is rolling—and there will be no stopping it. Investor priorities have changed—and with ethics and environmental concerns making such a huge entrance into the world of investing, it’s unlikely that ESG investing will see anything other than rapid growth and expansion in the years and decades to come.

Conclusion 🏁

So there you have it—and congratulations for making it to the end. ESG investing is an interesting topic—and it has a noble cause in trying to unite good morals with good business. Environmental, social, and ethical issues have an effect on each and every one of us—shareholders or not.

ESG investing is still gaining steam—but there’s no doubt that it will be a huge industry in five years’ time. Knowing the ins and outs of the criteria that businesses will have to meet ahead of time will give you a huge advantage over the competition—and will help you meet your financial goals in the future.

ESG Investing: FAQs

  • What Are ESG Funds?

    ESG funds are funds that screen the investments within them for environmental, social, and corporate governance factors to make sure that the businesses they invest in are both healthy and ethical.

  • What Companies Use ESG?

    Too many companies to count use ESG factors—after all, a good score is positive PR. However, to find which companies actually take ESG seriously, look at the companies that have the best ESG scores.

  • Is Tesla an ESG?

    Yes—Tesla is an ESG investment according to the S&P 500 ESG index.

  • Is Amazon an ESG?

    Most rating sources give Amazon low scores on various ESG metrics, so Amazon cannot be considered an ESG investment.

Get Started with a Stock Broker

Fees
Commissions

$0

$0

Minimum initial deposit

TS Select: $2,000

TS GO: $0

$0

Account minimum

$0

$0

General
Best for

Active options and penny stock trading

New investors

Highlight

Powerful tools for professionals

Value-based investing

Promotion

$5 bonus¹

Rating
Fees
Commissions

$0

$1, $2, or $3/month

Minimum initial deposit

$0

$0 to open account

Account minimum

$0

$5 required to start investing

General
Best for

New investors

People who struggle to save

Highlight

Value-based investing

“Invest spare change” feature

Promotion

$5 bonus¹

Rating
Fees

Commissions

$0

$0

$1, $2, or $3/month

Minimum initial deposit

TS Select: $2,000

TS GO: $0

$0

$0 to open account

Account minimum

$0

$0

$5 required to start investing

General

Best for

Active options and penny stock trading

New investors

People who struggle to save

Highlight

Powerful tools for professionals

Value-based investing

“Invest spare change” feature

Promotion

$5 bonus¹

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

Cookies & Privacy

The Tokenist uses cookies to provide you with a great experience and enables you to enjoy all the functionality of the site.