Monday, August 2, 2010

The ABC's of ESG

Just as in any industry, the responsible investment (RI) industry is full of jargon, abbreviations and acronyms. This post will familiarize you with common terms we use.
  • Responsible Investing (RI) or Socially Responsible Investing (SRI) - An investment philosophy and practice that considers social, environmental, and ethical criteria in addition to financial criteria when making investment decisions. Many investors believe that these factors can be determinants of business value. The term often encompasses many different RI techniques (some are defined below) including positive and negative screening, ESG integration, proxy voting and shareholder engagement. It is also closely related to other finance and investment practices such as social finance, community investing, mission-based investing, and microfinance, which directly seek out both financial returns and social benefits when making each investment.
  • Environmental, Social and Governance (ESG) - The term ESG is often used to describe the types of issues commonly examined by responsible investors when evaluating a company, sector or investment. Common ESG characteristics include:
    • Issues commonly considered non-material or non-financial by traditional financial analysts (for example the effect of a protest on a company's reputation may not have immediate or significant financial consequences, but is often still a concern to responsible investors)
    • Issues where effects (positive and negative) are felt over a medium or long-term time horizon (climate change is a classic long-term example and the sub-prime mortgage crisis is a good medium-term example)
    • Issues that create externalities, where the costs and effects are not captured by or priced into the market and are borne by other companies or society at large (for example, water pollution by heavy industry has a significant impact on society and often the health and clean-up costs are passed onto citizens)
    • Issues that arise out of changing regulatory or policy environments, or through changing societal expectations (for example companies are increasingly expected to 'give back' to the communities where they operate through donations and development projects)
    • Areas of public concern or focus (such as the environmental risks of off-shore oil drilling following the BP oil spill in the Gulf of Mexico)
  • Shareholder Engagement - A strategy used by investors to improve the environmental, social and governance performance of companies in their portfolios through direct formal and informal communication with companies. Shareholder engagement techniques include in-depth research, phone calls, letter writing and meetings with company management, attending and asking questions at annual general meetings (AGMs), filing shareholder proposals, and voting at company AGMs. Many investors believe that shareholder engagement can help identify and mitigate investment risks through proactively discussing shareholder concerns with company management.
  • ESG Integration - An investment process whereby investment managers systematically include environmental, social and corporate governance criteria when deciding what investments to buy and sell. ESG criteria are used to identify additional investment risks and opportunities that traditional financial analysis may overlook.
  • Positive & Negative Screening - Screening is a technique used by many investors to help select the most responsible and ethical companies for investment, and to eliminate the worst corporate actors from their portfolio. Positive screens often identify the best performing companies based on a set of pre-determined ESG criteria, while negative screens identify the worst performers. Investors can choose the types of screens they want to apply, for example they can choose to eliminate all investments that derive profits from tobacco or weapons.
  • Institutional Investors - Large institutions that manage money on behalf of other people (their 'beneficiaries'), such as investment managers, pension funds, foundations, mutual funds, insurance companies, and sovereign wealth funds.
  • Retail Investors - Individuals that invest in the stock market or other investment vehicles for their personal and retirement savings.

Definitions compiled in part from:
Translating ESG into sustainable business value, by the UN Environment Program Finance Initiative (UNEP-FI) & World Business Council on Sustainable Development (WBCSD)

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