ESG INVESTING -
WHAT IS IT ALL ABOUT?

Looking for an ethical investment option but not sure how to go about it? Learn about the history of ESG investing, how to determine whether a stock is ethical and everything else you need to know before getting started.

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Increasing numbers of investors are starting to use their portfolios to show just how concerned they are about many of the issues facing our planet and its people. Many of them do so through a concept called ESG investing, which has become increasingly popular since the turn of the century and has continued to grow in 2021.

So what is ESG investing, and how can you use your conscience to help target future investing opportunities? Read on to learn more about the history of ESG trading, its pros and cons, how you can find ESG stocks and if investing in them might be right for you.

What does ESG stand for?

ESG stands for environmental, social and governance. In the stock investing world, ESG stocks are those of companies that emphasise some or all three of these criteria in their everyday operations. Businesses can prioritise these factors in all sorts of ways and with a variety of actions.

Environmental criteria include:

1. Considerations around how much sustainability is built into production processes and the supply chain.
2. Where a company allocates its own investment capital.
3. Its stance on climate change and efforts to fight it.
4. Dedication to renewable energy.
5. Using recyclable packaging and other green practices.
6. Donating to environmental groups.

Social factors centre on how companies treat human beings in all aspects of their business. Some considerations may include:

• Do employees work under safe, fair and comfortable conditions?
• Are workers’ rights being respected at every stage of resourcing and production (including ethical business practices overseas)?
• Is there a commitment to diversity and recognising other prominent social issues not only within the company, but also across society at large?

Finally, governance refers to how a company is run at various levels. This includes transparency with customers and shareholders, diverse hiring practices at the highest levels and how many different voices there are in relation to how the company is run.

Some stocks that have rated well in a range of ESG factors (more on this soon) in recent years include:

• NVIDIA
• Microsoft
• Pool Corporation

What is the history of ESG investing?

The precursor to ESG investing was socially responsible investing (SRI). SRI investing has a history dating back hundreds of years to when the Quakers refused to profit from anything related to slave trading.

More recently, in the 1960s, 70s and 80s, investors started to exclude businesses from their portfolios that were involved in activities that did not align with socially conscious interests. Examples included participating in the tobacco or alcohol industries and supporting apartheid in South Africa or the Vietnam War.

ESG investing vs. SRI investing

So, how is ESG investing different from SRI investing? Both are examples of ethical investing. However, there are some key differences to bear in mind.

ESG investing and SRI investing involve using morals and ethics as a guide to choose where to invest. However, the lengths to which these factors guide your decisions differ depending on which strategy you use.

The main difference is that SRI investors use moral and ethical factors to completely eliminate companies as investing possibilities. You remove them from your list of options regardless of how well you think they might perform in the market.

ESG investing still takes environmental, social and governance factors into account, but not always to determine the positive impacts they might have on people and the planet. These factors are often used to try to predict how profitable investing in a company might be. In general, ESG investors believe those companies that score well in those three areas have a better chance of performing well financially.

What are the pros and cons of ESG investing?

As with all investment strategies, there can be positives and negatives to ESG investing.

One pro of ESG investing is that using this set of criteria can help you invest in companies that might have a lower chance of risky stock price drops due to negative attention, potentially assisting in managing your risk as an investor.

Companies that consider the environment, adhere to strong beliefs in key social justice issues and are transparent, might be less likely to be involved in major scandals that can cause dramatic drops in share price. This does not mean that ESG companies are risk-averse generally — simply, that they’re less likely to receive negative press due to social issues.

At its heart, ESG investing aims to help investors understand the wider approach of a company beyond simply making a profit — enabling investors to make informed decisions.

The UK’s FCA has outlined their approach to ESG and the importance of this type of investing. Climate change stands as a firm priority within their relationship with ESG investing, alongside a company’s ability to “drive positive change, for the benefit of its shareholders, clients and consumers, employees and wider society.”

As opposed to SRI investing, ESG investing does not eliminate businesses as investment opportunities — it just might rate them lower. This means moral and ethical constraints do not preclude you from seizing a strong investment opportunity. Another pro outside of portfolio performance is that you can invest in companies whose beliefs you share, which can bring another level of satisfaction to trading.

But there are cons to ESG investing, too. One is that there are not many standardised criteria around ESG investing. That can make it a little more difficult to determine what is truly ethical and has seen a rise of ‘greenwashing’, where companies allude to being sustainably conscious when they are not.

Positively, standardised criteria is arising on a global level, with clear definitions presented by the SRFD in the EU, as well as the ESG and TCFD in the UK so far.

Another con is that it can be hard to find sufficient information that shows just how well a company is performing in the three ESG criteria. As you’ll see in a moment, there are things you can do while researching to see how well companies do, but it’s hard to know every detail about the inner workings of a business and its ongoing practices.

How can you determine if a stock is sustainable?

You can determine if a stock is sustainable in a few different ways.

Rating systems

One is through the wide range of rating systems out there from trusted sources.

Free-to-access ESG Book helps investors compare and contrast how companies in different industries rank in key environmental, social and governance metrics. Users can check the sustainability data of over 25,000 corporates worldwide on ESG Book, with a range of daily scores to assess performance on a wide range of ESG topics.

ESG reports

Another way to find out if a stock is sustainable is by doing some outside research to see if any of the companies you are considering have released ESG reports. As increasing numbers of investors are placing the three key criteria at or near the top of their investment focus, companies know the importance of sharing their wins in those areas.

That is why this has become more common across a range of industries. Unlike standard earnings reports, these companies decide which information to share in ESG reports — and also what to keep hidden from public view. But knowing that companies are making any efforts in all or some of those key ESG areas can help you make your investment decisions.

What are ESG scores?

ESG scores are ratings given to companies based on how well they perform with regards to generally accepted environmental, social and governance standards. Since there are no concrete thresholds for these three areas, these ESG scores can vary from provider to provider.

While several countries such as the UK are making movements towards standardising ESG scores, there is not yet currently anything in place globally. However, they generally work in the same way.

The scoring provide will use a collection of performance areas that fall under the three main tenets of ESG investing. These providers will rate businesses based on how well they do in those areas. This provides an accessible and quantitative way to compare companies.

For example, ESG Book’s proprietary scores allow investors to measure companies on individual ESG topics, in addition to other metrics including UN Global Compact scoring and Paris Goal-aligned 1.5°C climate warming scenarios.

While dozens of these performance areas exist across the huge range of ESG scores out there, a few include:

• Human rights
• Employee health and safety
• Diversity
• Public health
• Environmental efforts.

What strategies can you use to assess ESG scores?

While ESG scores can be helpful when comparing companies, there are several strategies that can be used to help further you decide how you’ll invest. These strategies include exclusionary screening, positive screening and negative screening.

Exclusionary screening

Exclusionary screening is a strategy that involves excluding select companies from your portfolio that don’t align with personal values or that don’t meet global standards.

While your actions may not necessarily lead a company to change its behaviour, well-coordinated divestments can potentially be effective. It’s important to note, however, that excluding high-performing companies from your investment strategy may limit future your portfolio’s future performance.

You might choose to exclude companies from your portfolio based on their ESG score or specific behaviours, such as generating revenue from the sale of tobacco.

Positive screening

A positive screening strategy sees a portfolio include companies that outperform their competitors on ESG matters, implement ESG measures ahead of others, or solve ESG challenges. Much like exclusionary screening, this strategy aims to reduce ESG risk. It also focuses on supporting business models that address ESG issues and improving a portfolio’s overall ESG score.

While more resources are providing ESG data, it can still be difficult to source quality information. It’s essential to consider this when employing this strategy.

The strategy typically rewards companies with higher ESG scores with additional capital. It is often targeted to companies operating in specific sectors or addressing certain themes, such as gender diversity and climate change.

Actioning a positive screening strategy could, for example, involve investing in companies with a high ESG score or selecting an investment that is determined to be less harmful to the environment.

Negative screening

Negative screening strategies see investors exclude investments with lower ESG scores to mitigate potential risk and prioritise financial returns. The strategy is implemented through the qualitative and quantitative assessment of ESG factors, with a long-term view of the company required to achieve a balanced assessment.

Much like other strategies, negative screening aims to mitigate ESG risks and achieve higher returns for the investor. Some examples of the strategy in action could include choosing not to invest in companies with a low ESG score, either in general or when compared to others operating in the same industry.

Why are people turning to ESG investing?

Like all stock investment strategies, ESG investing might work for you depending on what your goals are. It can act as a compromise — it gives you a chance to exercise some ethical and moral behaviour without the stricter aspects of SRI investing.

It can also lead to great returns if you think ESG properties are important to a company’s success. And with more and more ETFs and other funds out there dedicated to ESG investing, it can be easy to get started.

What are some popular ESG stocks on eToro?

If you’re ready to start exploring the big, wide world of ESG investing, we’ve rounded up three of the most popular ESG stocks that you can start buying on eToro today.

Nvidia Corporation

• NVIDIA produces and sells graphic processing units for the gaming industry, as well as system-on-a-chip (SoC) units for the automotive and mobile computing industries.
• NVIDIA’s strong ESG rating and strict policies around its sourcing of minerals for its products have established the company as a leader in the ESG movement.
• The company has shown strong returns over several years, with a current share price of $316.75*, reflecting a 135.72% year-on-year return.

Microsoft

• Microsoft is known for its software and cloud technology, and as a popular blue chip stock with a steady revenue increase year-on-year.
• Microsoft has also been at the forefront of the ESG movement, with a commitment to reaching 100% renewable energy usage by 2025.
• By 2050, Microsoft also plans to offset all carbon emissions it has produced since 1975. As of mid-November, Microsoft’s share price was $341.27* with a one-year return of 60.57%.

Pool Corporation

• Pool Corporation is a wholesale distributor of swimming pool equipment, parts and supplies, as well as related outdoor living products.
• With a major distribution network spanning 360 worldwide locations and stocking 180,000 national brands and private label products, Pool Corp. is a large player in the consumer goods industry. 
• The company also has a strong ESG rating through its selection of Eco Select products, involvement in EPA’s WaterSense program, educational resources surrounding water management and its variety of charitable donations.
• In 2020, Pool Corporation’s revenue increased by 23.04% and amounted to $3.94B.The share has grown 70.52% over the past year and is currently valued at $577.85*.

* Stock price current as of November 18, 2021.

As mentioned earlier, other big names with strong ESG ratings include:

• Nike
• Salesforce
• Accenture
• Adobe
• Alphabet

There may be more options than you know, where companies are doing incredible work in the ethical, sustainable and governance space. These ESG stocks — or ESG ETFs — can be one way of investing in companies aligned to your values.

Sign up with eToro and invest in ESG stocks.

FAQ

Are there any other risks of ESG investing?

Another potential risk is that companies could stop voluntarily sharing their sustainability data. If this were the case, it could be difficult to determine whether a company continues to operate ethically, reducing the number of potential ESG investing opportunities.

What are the PRI?

The Principles for Responsible Investments (PRI) were formed in 2006. They are a set of United Nations guidelines outlining how ESG factors may be incorporated into business policy and strategy. The PRI have more than 2,000 signatories.