A company must observe and be aware of the natural environment around it, and that entails following environmental, social, and governance (ESG) criteria. Those criteria consist of a list of requirements that the company has to follow within its operations. This is usually the case when a company depends on investors to fund its operations. Those investors are usually environmentally conscious and inspect the grounds of a company to ensure that it is abiding by the guidelines that come with the investment.
In early 2018, approximately $11.6 trillion worth of assets in brokerage and mutual fund companies were held by investors who sought to support environmental social governance standards. As the years go on, more investors are finding value in companies that follow those standards. That is due to the fact that a younger generation of investors is showing interest in funding organizations that align with their values. It is that reason that Robo-advisors like Betterment and Wealthfront choose to market towards that group of investors. This kind of investing is often called sustainable investing because it involves investors putting their money towards causes that support environmental social governance.
What are Environmental, Social, and Governance Criteria?
A few areas that are taken into consideration when it comes to these specific criteria include a company’s treatment of animals, natural resource conservation, pollution, waste, etc. If a company isn’t complying with government regulations or failing to properly dispose of hazardous waste, then it isn’t meeting environmental social governance criteria. This can also include the way a company is managing its losses versus gains. As far as social criteria go, the organization’s business relationships are considered. If a company claims to value environmentally friendly products and services, it should only partner with suppliers that are indeed environmentally friendly. Not only is that honest but it is also socially respectable. Working conditions should also reflect the company’s standards when it comes to fair treatment and sustainability. This could also include the company’s relationships with nonprofit organizations and whether or not it supports causes that truly matter to the company.
The governance of a company should involve clear and correct accounting strategies. This helps investors understand the company’s methods and can have some kind of say in the way the company chooses to spend its money. This may usually involve the company making decisions for the sake of board member’s wishes and interests to ensure that unfair political contradictions are not taking place. This also avoids the occurrence of unethical or illegal practices within a company’s spending habits.
Priorities have to be put in place by companies and investors that want to follow ESG criteria. It isn’t always true that a company can stick to every rule under the three categories of environmental, safety, and governance. Some investors choose to put their money towards companies that fit their specific criteria. For example, an investment firm may specifically avoid companies that disregard specific issues such as companies that are associated with coal mining or use nuclear power. Trillium Asset Management, for example, avoids those kinds of companies as well as those that are involved with any major controversies that involve discrimination, animal, etc. The company was inspired by the findings of analysts that discovered that some issues impact certain issues more than other issues.
Advantages and Disadvantages of ESG Criteria
From an investor’s perspective, socially responsible investments have been known to come with tradeoffs. They are only able to put their money towards that follow their priorities when it comes to socially and environmentally responsible companies. While it may seem like they are able to save their money by being so selective, it also hinders their ability to make a substantial profit in the long run. For example, an investor that only supports companies that use clean energy may be losing money when companies that use greenhouse gas emissions are on the top of the industry. That may be due to the fact that the companies that do not meet their criteria make more sales and higher profits despite their lack of consideration for this criteria.
However, investors are often at luck because investing in companies that meet the standards often puts them at less of a risk in terms of accidents and casualties. Investment firms will continue to track the progress of companies that choose to follow the criteria which can change over time as those socially conscious organizations gain more traction.
