What is ESG?
Over the years, environmental, social, and governance (ESG) initiatives have evolved from emerging trends to pivotal in transforming the corporate landscape as people become more aware of environmental and social concerns. With ESG interest on the rise, business owners may be wondering how they can help keep up the momentum. As a first step, to better understand what ESG is, here’s a breakdown.
- Environmental – This concept considers the implications of waste management, carbon emissions, resource scarcity, energy efficiency, etc.
- Social – Social performance indicators include a company’s relationship with the community, philanthropy interests, exploring diversity opportunities, workplace injury rates, how a company manages customer privacy, data and reporting on socially responsible projects, and more.
- Governance – How the company is run and structured. Diversity of the board of directors and their role. Oversight of top executives, delegation of responsibilities throughout the organization, and other corporate governance-related issues.
The pressure to focus on ESG programs doesn’t just come from investor circles; modifications on regulations by governments globally are consequently encouraging companies to move forward with their own ESG principles. The Securities and Exchange Commission is already developing metrics on how to analyze and report on sustainable operations and products.
A few leaders in adopting ESG include companies such as Google, Intel Corporation, LPL Financial LLC, PepsiCo, Inc., Apple Inc., PayPal Holdings Inc., and Microsoft Corporation.
Why is ESG Important?
ESG initiatives are essential because they work to make operations environmentally and socially sustainable. Investors are attracted to ESG companies, and businesses that don’t pursue an ESG program risk missing out on business opportunities. According to an Edie report, approximately 74% of the world’s largest investors focus on ESG investing.
What are the benefits of ESG?
Companies can benefit from ESG as it drives new business and interest from investors. A strong ESG program can help keep companies operating more efficiently, ensuring resource allocation management and lowering operating expenses, for example, water, energy, and waste management. A company that maintains strong ESG practices may be a safer long-term investment, especially if they have products that are conducive to the evolving sustainable technology.
What are the challenges of ESG?
A significant disadvantage to adopting ESG criteria in your business is that companies are not required to disclose information about their sustainability strategies. Because of this, investors might find it challenging to evaluate their investments' true environmental and social sustainability impact.
Another disadvantage might arise for companies with limited resources as implementing ESG practices requires significant money, time, and human capital. There has yet to be one standard for measuring ESG effectiveness, which may make it more difficult for investors to make informed decisions.
ESG investing also has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
Should you integrate an ESG strategy into your business?
Here are seven reasons you may consider adopting ESG practices in your business.
- Reducing your carbon footprint – Managing your carbon footprint helps to mitigate the adverse effects on the environment, including reducing the contribution to air pollution and toxic rain, human-induced climate change, ocean acidification, and the melting of the polar ice caps.
- Working to preserve biodiversity – Biodiversity helps support the ecosystem instead of damaging or disrupting it and is essential to sustain life. It helps to maintain the community's food security, fight disease, and manage elements of human-caused climate change.
- Renewable energy – Investing in companies with ESG initiatives, particularly with renewable energy projects, helps support a positive, environmentally aware approach to embracing clean energy.
- Higher returns on equity – Investors in companies with ESG practices have greater long-term success than those that haven’t adopted this strategy, as ESG funds and stocks can potentially help alleviate portfolio risk and grow returns.
- Higher valuation – With all other things equal, companies with a lower cost of capital would likely have a higher valuation.
6. Lower risk – Companies with ESG initiatives and a transparent model can influence investment decisions where investors can get behind a company with goals for a sustainable future with a low-risk profile.
7. Identify investment opportunities – Investors interested in ESG companies get a more holistic approach to the companies they support. As companies begin adopting these principles, it creates more investment choices for investors.
How to get started
Adopting and applying ESG standards could have a positive impact not only on the environment, but your business reputation and growth as well. Due to the risks involved with any investments, the complexity of analyzing and evaluating a company, and the consistently evolving market, particularly concerning ESG practices and companies adopting these initiatives, you should consider consulting a financial professional to learn how potential decisions might impact your business financial goals and long-term strategy.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
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