What Does ESG Stand For?

If it feels like you’ve been hearing more and more about “ESG investing,” you’re not alone. Although an ESG investing framework has existed for decades, it is truly within the last few years that ESG has gone mainstream with a wider audience of investors.

But what does ESG stand for? How does it differ from other investment philosophies? Here’s what you need to know.

What does ESG mean?

ESG is an acronym for a set of criteria investors will use to evaluate investment opportunities when following an ESG investment philosophy. ESG stands for environmental, social and corporate governance.

What is ESG investing?

ESG investing considers a company’s track record when it comes to the environment, social equity and corporate governance. Like most investors, ESG investors seek to maximize their investment returns while limiting risk. Where they differ, however, is in the consideration of these additional factors. In building a portfolio, ESG investors will examine how a company approaches ESG factors and choose to invest in companies that set and maintain certain standards.

What are the ESG criteria?

There are no specific benchmarks that companies must hit to be considered an ESG investment. In fact, many brokers, corporations and fund managers may build their own definition of ESG by identifying relevant issues and setting their own criteria for how they’ll evaluate companies. However, there are some general standards that investors will likely be looking for when evaluating a company.

Environmental

Companies that earn high environmental grades may produce or invest in products that help clean wastewater or generate renewable energy. They may have a concrete plan for reducing greenhouse gas emissions from operations or sourcing their products sustainably. Companies that address environmental concerns well may also be involved in environmental cleanup efforts, reducing their carbon footprint and participating in efforts to address current environmental concerns.

Companies that score poorly here may produce products that yield environmental hazards or contribute to greenhouse gas production.

Social

Companies that score high in social measures demonstrate a commitment to their workforces and the communities in which they do business. These companies will have diverse workforces, fair hiring practices and products sourced without labor exploitation. These companies are also typically good to employees—offering competitive salaries and benefit packages—and they may participate in community outreach or get involved in local organizations’ efforts.

Companies that score poorly here may have a history of human rights violations, workplace issues and other business practices that are a burden on the workforce or surrounding community.

Governance

Finally, governance is focused on how a business is managed. Companies that rank highly in governance allow feedback from shareholders, communicate transparently and use fair and open accounting practices. These companies also usually maintain an effective, accountable and diverse board of directors with clear and separate roles established between the board and senior management.

Companies that rank low here may have run into issues with the SEC and shareholder lawsuits, deceptive leadership and executives with questionable pay incentives.

Pros and cons of ESG investing

As with considering any investment, you’ll have to weigh the pros and cons of using an ESG investment strategy. Here are some thoughts to consider:

Pros of ESG investing

While there’s no uniform definition of ESG, and it’s still a relatively new investment style, companies that tend to focus on these areas have typically performed better than those that do not. At a minimum, they tend to have less risk than companies that do not focus on these factors.

Regardless of performance, as an ESG investor, you can feel better about supporting companies that align to your values.

Cons of ESG investing

ESG alone is not a financial measure, which is typically where you would first focus when evaluating an investment. While it can be a good filter to apply to an investment opportunity, focusing solely on companies that align to your values is unlikely to give you enough information to build a well-diversified portfolio to help you reach your financial goals.

You may also limit yourself if you exclude companies that don’t score high on all ESG factors (by excluding sectors like energy or defense contracting).

Other key ESG investing terms

ESG investors are driven by the dual goals of realizing a profit while supporting businesses that are also considered to be environmentally, socially, and governmentally responsible. As such, ESG investing is synonymous with a few related terms:

• Values-based investing: An investment strategy in which investors make investment decisions based on their own personal values, religions or political beliefs

• Socially responsible investing: An investment strategy in which investors seek socially responsible companies

• Ethical investing: An investment strategy in which investors only invest in companies deemed to be “ethical” while also avoiding companies deemed “unethical”

• Sustainable investing: An investment strategy in which sustainability and environmental impacts are heavily considered

• Impact investing: An investment strategy in which investors strategically deploy their capital with the goal of having a positive impact aligned with their personal values

Is ESG investing the same as sustainable investing?

While each of these terms is slightly different, they all align closely with ESG investing. Though several trade organizations have created benchmarks to measure ESG practices, keep in mind that there’s no “global standard” measure for a company that’s sustainable or ethical. Brokers, corporations, and fund managers may also build their own definition of ESG (or use a third-party benchmark) that they will publish or disclose.

Where to find ESG information

If you’re interested in ESG investments and want to learn more about a particular company’s track record, you have a couple of different options for how you’ll get this information.

How do I know which investments are ESG?

Several third-party data firms have built out frameworks to independently evaluate and score a company’s ESG credentials. Oftentimes, you’ll see an ESG scorecard on a stock or fund website. The scorecard will typically contain an ESG score or letter grade for the company as well as other relevant information about the asset (like the asset class, risk or expense ratio).

Researching ESG investments on your own

You can also do your own research into a company to gauge its track record on environmental, social or governance issues. Many companies have pages on their websites dedicated to their social and sustainability initiatives, which can be a good source of information. You can also visit reliable industry or news outlets to get a sense of how the company does business or learn about any major news from the company—good or bad.

How to get started with ESG investing

If you are a hands-on investor who likes to choose individual companies to invest in, then you will ultimately need to evaluate any potential investment on both its financial performance and ESG performance. You can do this by conducting your own research into each company’s business practices. There are also ESG mutual funds and ETFs you may want to consider. These funds are managed to include companies with a focus on ESG while providing you with diversification.

If you are considering working with a financial advisor or wealth manager, ESG investing is a good reason to seek advice. A Northwestern Mutual financial advisor can provide a personalized approach to ESG investing. The advisor can get to know your values and opinions and help you understand the many different options available to invest in ESG—like with your 401(k) or by purchasing stocks. An advisor can also help you integrate ESG investing into your broader investment and financial plan, which can help ensure that you are getting the growth you need to achieve your long-term financial goals while helping further ESG causes.

There is no formal definition of an ESG investing style and ESG factors may be subjective and defined differently by fund managers or sponsors. As with any investment, you could lose money and investing in an ESG Fund should fit within your overall investment goals. ESG funds often take more work for fund managers to construct and manage and, consequently, can cost more than a passive fund that tracks a broad- based market index. A portfolio manager’s ESG practices may significantly influence performance.