How ESG factors can add up to financial investment

Potential, performance, and financial support: Read how criteria for ESG factors impact investors’ decision making.

Diletta Manago

by Diletta Managò

Today, it seems that all eyes are on ESG. As the world keeps a closer watch on companies’ ethics, investors are scrutinizing more carefully their efforts to be environmentally and socially conscious. The concept of sustainable investment has been around for decades, emerging at the end of the 1960s. Since then, ESG factors have become a hot topic – and many companies have been burned by poor ratings. But how do investors transform this concept into a concrete evaluation of companies’ sustainability? And how can businesses align with what they’re looking for? The answer: ESG criteria.

What are ESG factors & criteria?

ESG refers to businesses’ efforts to operate ethically, measuring 3 extra-financial indicators:

  • Environmental: How a company performs as a steward of the natural world in which it operates,
  • Social: How a company addresses  its social relations with employees, customers, suppliers, institutions and/or the global community within which it acts, and
  • Corporate governance: How a company manages its system of practices, procedures, and controls to oversee its internal behavior.

After a long period of being dismissed as low(er) priorities, these ESG factors now play a central role in direct investors’ decision-making. Looking at how companies address these issues helps to unlock crucial information on their long-term resilience and profitability. And ESG criteria provide a concrete framework for investors to effectively evaluate potential impact that isn’t measured in traditional financial reports. These ESG criteria include a variety of considerations, such as a company’s footprint on the environment, level of social inclusion, efforts to promote gender equality, as well as ethical executive compensation and tax transparency.

How do ESG criteria influence investments?

The logic behind ESG criteria is primarily to recognize the significant impact that a company’s conduct has on both the environment and society. However, there are practical reasons beyond being purely altruistic or ethical. Rather, measuring this impact can ultimately lead to better-informed investment choices. Integrating ESG factors into assessments can give investors a more holistic view on companies and their potential for durable business opportunities.

As such, ESG criteria serve as a compass directing investors towards companies that not only embrace certain values – but also are aligned with growing awareness and evolving regulations. With companies’ longevity and credit ratings increasingly connected with extra-financial issues, investors may see a weak commitment to ESG factors, such as environmental policies or employee well-being, as too much of a risk.

How can ESG factors affect companies’ performance?

Some studies show that companies performing well on ESG criteria are more likely to generate long-term value and returns. According to a 2014 Oxford University`s study, of over 200 reviewed sources on ESG performances, an outstanding majority of 88% showed that solid ESG practices resulted in better operational performance.

In 2020, a NYU Stern Center for Sustainable Business report claimed a link between ESG and financial performance, generally finding a positive correlation. And more recently, Morningstar’s 2021 Sustainable Funds US Landscape Report concluded that “[s]ustainable funds comfortably outperformed their peers in 2020.”

The bottom line on ESG factors: A new reality for risk & reward?

In order to unravel today’s complex reality of a company’s worth, investors are widening their view beyond the traditional risks and returns. Instead, they’re looking to understand businesses’ real potential through their level of corporate social and environmental responsibility. While sustainable investment is still developing as a concept (and even still being debated), ultimately, companies can expect that the (intensely) growing societal attention to ESG factors will increasingly influence investors’ decisions. Companies can use ESG criteria as a guide to align their operations with potential investors.

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