The ABCs of ESG: Evaluating the social practices of a company
You may have heard of ESG investing, but what is it really? ESG investing focuses on identifying companies that have strong Environmental, Social, and Governance ratings. While the Environmental component of ESG is often clear and easy to understand for individual investors (think greenhouse gas emissions, pollution, and usage of recyclables and renewable energy), the factors considered for a Social rating can be less obvious. Part one of our two-part Perspectives series on ESG investing will focus on the “S.”
Social factors encompass a wide range of topics related to how a company impacts all of its “stakeholders,” including employees, customers, and the communities in which it operates. For example, companies that treat employees as partners would typically receive higher ESG scores. Labor relations, workplace safety, training and development of employees, and labor standards of both the company and those of its suppliers factor into the human capital component of the Social rating.
A company’s products and services also have an impact on stakeholders. Risks vary across different industries, and can include the quality of a physical product, the safety record for a product, or whether a product poses a health risk. For example, a tobacco company would score low on measures of product health risk. Financial services companies are exposed to different product risks, such as whether product fees are appropriate or if the service meets a legitimate financial need. Both financial services and technology companies are also evaluated based on how they mitigate risks related to data privacy and security.
Finally, Social ratings consider how a company positively impacts the broader community. Health care companies are rated favorably if they have programs in place to ensure access to medicine for patients around the world who cannot afford to pay. Providing communities in need access to low-cost communication and financial services can also differentiate a company relative to its peers.
An increased focus on ESG investing is pushing companies to be more attentive to how they impact the world around them. By factoring ESG into portfolio construction, an individual investor has the ability to direct his or her investments towards companies that strive for excellence and push their industry peers to improve as well.
Stay tuned for part two of this Perspectives series, which will focus on the “G” in ESG investing, and for more information, contact your D.A. Davidson financial advisor.
Source: MSCI
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