By GLOBUS Correspondent Diogo Santos
We have all heard of investing before, but what is it? Investing refers to the action of allocating resources, usually money with the expectation of generating future profit. It can take many forms such as buying stocks, bonds, funds, real estate, commodities, and many more. For the purposes of this article, I will be focusing on stocks and funds whenever I refer to investing.
Stocks and shares are little pieces of businesses that you can buy on the stock market. Think of it as owning 1% in a local bakery, but on a larger scale. It allows you to participate in the growth of businesses around the world as technologies and business techniques develop and productivity increases. In the process, these shares tend to appreciate over time and reward the investor with financial returns. It also provides businesses with the opportunity to raise capital through the financial markets, which in short means that investing in businesses not only allows you to partake in their growth, but also support them in their business journey.
Funds are simply a collection of such shares and often other types of investments aimed at lowering the risk of investing by spreading the money across multiple assets.
Many of us have heard that investing is probably something we should do, but it sounds complicated and tedious and thus, many of us keep putting it off. Many others have never heard of it before or have always thought it was only reserved to ‘big banks’ and ‘rich people’. I am here to tell you all those preconceptions are wrong. Investing can be simple and easy, and you don’t need large amounts of money to do it.
Investing in funds allows you to spread your money through hundreds or thousands of investments with one purchase. This is what a lot of investors who want solid returns and simplicity opt for. Historically, picking a few broad index funds that allow you to invest in the wider market, and holding them for the long term has produced brilliant results.
Now we have established the benefits of investing and why it may be something you may want to investigate, but how does it have anything to do with the environment, climate change or the ESG framework? The answer is – ESG Investing.
ESG stands for Environment, Social, and Governance, and constitutes three main areas of interest for “socially responsible investors”. It allows investors to incorporate their values and concerns, such as environmental concerns, into their selection of investments instead of simply considering the potential profitability of an investment.
The environmental criteria consider the company’s use of renewable energy sources, its waste management program, how it handles potential air and water pollution arising from operations, deforestation issues, and its attitude and action around climate change issues. Other considerations could include raw material sourcing and the company’s biodiversity practices in the land it owns or controls.
The social criteria encompass a wide range of issues with regards to how a company views and treats people involved or impacted by their operations (stakeholders). Some issues that may be considered include:
- Employee fair pay compared to similar positions throughout industry.
- Extra perks and benefits offered to employees outside of basic salary.
- Policies regarding diversity, inclusion and prevention of sexual harassment.
- Employee training and education programs
- The company’s mission statement: Is it beneficial to society?
- Company’s public stance on human rights issues.
- Level of employee engagement with management. Is employee input taken into consideration?
The governance criteria relates to how the company is managed by top executives. Does executive management and the board of directors’ care for the needs of the various stakeholders? Do they give back to the local community? Financial and accounting transparency are key components to good corporate governance as well. Executive compensation is also a key consideration for various ESG investors. Is executive remuneration fair and in line with long-term value, viability, and profitability of the business? Lastly, does executive bonuses also consider factors such as employee, shareholder, and customer satisfaction?
ESG investing is therefore, investing in companies that focus and operate around the ESG framework instead of just aiming for profits. Various agencies rate companies in terms of ESG and also conduct ESG analysis on them which may be useful for ESG investors looking to pick individuals stocks. However, for many of us who wish to invest simply over the long-term funds are usually the better option as discussed earlier thus, ESG funds may be the appropriate vehicle to do so.
ESG funds, much like normal funds are a collection of stocks and other assets bundled together to provide a diversified method of potentially lowering risk. However, unlike normal funds, ESG funds will only include stocks which meet a certain benchmark using the ESG framework. For example, some ESG funds focus on companies that are actively trying to make a difference in the environment, sustainable energy, reforestation, etc. Others, include companies that only meet a certain level in each of the three sections of the ESG framework. Each ESG fund is different and depends on the manger’s (of the fund) goals.
However, ESG investing also has its limitations. Whilst the concept is clearly a good idea, it is incredibly hard to accurately measure a company’s level of ‘ESG-ness’. Almost all of the criteria are incredibly hard to quantify which leads most if not all ESG ratings to be quite subjective, as techniques to measure ESG principles are still in their infancy. This is a huge problem as most of you know that for something to be reliable and trustworthy it has to be analysed in a fair, unbiased manner. Yet right now companies and their level of ESG are being evaluated in-house my asset management firms and each of them differs in their analysis criteria. Therefore, when investing in ESG assets it is many times quite hard to determine to which extent the ESG fund you are purchasing is actually sustainable or responsible, and if you are actually making a difference.
In conclusion, though ESG funds and investing is still in its infancy, it is a mechanism that allows you to position yourself positively in financial terms whilst aiding companies that are helping their stakeholders, communities and the world grow into the future.
Disclaimer: Everything in this article is purely for entertainment and educational purposes only and should be in no case taken as financial advice.
Header image by Towfiqu barbhuiya via Unsplash
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