At first, it looked like almost everyone was on the ESG bandwagon. Then there were those who couldn’t wait to get off.
What’s going on?
Investing in companies with a corporate strategy that incorporates ESG may resonate with your values but one still needs to beware of ESG issues and potential pitfalls that go with it.
What Does ESG Stand For?
ESG stands for Environmental, Social, and Governance. It’s a risk management framework that helps decision-makers in organisations manage environmental, social, and governance risks and opportunities.
ESG measures a company’s sustainability risk using non-financial factors, with strategic objectives that go beyond environmental concerns. These days, investors as well as other stakeholders (customers, suppliers, and employees) are interested if board members make business decisions that consider managing risks related to ESG.
The 3 Pillars of ESG Are –
At the centre of this portfolio and capital altering movement are the three pillars of ESG risk management framework: Environmental, Social, and Governance practices.
Environmental:
- Evaluates risks of an organisation’s impact on the planet. This is how an organisation contributes to environmental risks such as climate change, carbon footprint, and waste management among others.
Social or Corporate Social Responsibility (CSR):
- Evaluates risks related to how an organisation impacts people including its employees, customers and the general community. Does the organisation encourage employees to be good corporate citizens?
Governance or Corporate Governance:
- Evaluates governance issues of an organisation. Is it transparent? Honest? Clear on its activities?
A business that is mindful of its internal and external environment, carbon footprint, relationship with community groups, and transparent with its affairs will most likely be attractive to investors.
What are top ESG risks?
One of the most important aspects of ESG investing is it takes into account how the company performs as a steward of our natural environment, treats people, and governs and polices itself. Done well, values-based investment processes such as
ESG investing can encourage companies to change and make the world a better place.
So if an ESG-based portfolio helps you incorporate your values and reach your financial goals, what are its potential risks?
ESG Risks Examples:
Here are a few ESG factors you need to know about ESG or responsible investment.
- Companies can get passing ESG scores even if you oppose their policies. The purpose of ESG analytics is to help most companies do better work. But some companies that you think aren’t good enough can still end up in your fund portfolio. You might have money in a tech company that mines rare earth minerals and dumps the waste in cesspools.
- There are no standard ESG criteria. You might think that a company’s ESG score is based on how well it helps the world. But they might be based on how well the policies make money for the company. ESG scores can be very different from one company to the next.
That’s because financial institutions and ESG rating providers conduct risk assessments of companies differently based on their own proprietary system, algorithms, metrics, definitions, and sources of ESG data or non-financial information. Most of these aren’t clear and rely on ESG reporting and internal audit from the companies they rate.
- ESG Fund fees can be higher, and may have less diversity. It takes research to figure out which companies should be included in the fund and which ones should be left out. This can cause fees to go up.
Typically, investors would want a diversified portfolio to help avoid short-term market swings while pursuing long-term goals.
Why ESG risk is important?
Similar to other business risks, an effective ESG risk management framework involves risk awareness (identified risks) and risk assessment leading to an effective operational risk management and decision-making.
ESG risks are real and identifiable challenges that effective risk management practices can help a company prosper if we consider the following:
- ESG focused organisations are more likely to develop loyal customers and attract and acquire new ones.
- An ESG company focused on resource efficiency whether energy, water, and even waste have a lower cost structure.
- ESG organisations are most likely to receive favourable regulatory outcomes.
- ESG organisations are most likely to attract high-calibre people.
Top talents now are looking beyond compensation, and some would probably identify an organisation’s ESG considerations with an executive team and senior management aligned with these values as their top priority. It’s a sentiment that’s reflected even in the investment market where investors assess if a company or fund is an ethical investment.
Learn More About ESG and Ethical Investing with Novo Wealth
Ethical investing weighs the positive and negative impact of your investments. Novo Wealth will help you make the right investment choices when integrating your values with your risk appetite.
We are the ethical financial advice specialist for professionals and business owners who want to invest responsibly, specialising in transitioning our clients from working life into retirement.
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