Get to Know ESG Investment


May 24, 2021

In recent years, ESG factors have been frequently discussed in the investment industry. Currently when climate change is being focused by the world, and the impact of COVID-19 pandemic reflects a variety of social issues, ESG investment becomes an even more popular topic among investors. This article is to provide a brief introduction on ESG investment.

Photo by Karsten Würth on Unsplash

The Concept of ESG Investment

ESG investment is to take ESG factors into consideration during the investment process. The ESG factors are short for Environmental, Social and Governance factors. When the United Nations launched its Principles for Responsible Investment in 2005, it defined Responsible Investment as “an approach to investing that aims to incorporate environmental, social and governance (ESG) factors into investment decisions, to better manage risk and generate sustainable, long-term returns.” So we can say that ESG investment is a responsible and sustainable investment strategy.

ESG Investment Approaches

1. Exclusions

Exclusions is an approach to avoid investing in companies and industries which are controversial to ESG factors. It is the most classic approach and is the most widely used at the moment. When applying this approach, tobacco, alcohol, weapons and gambling etc. are usually excluded. As time and people’s view change, the companies and industries to be excluded may also vary. For example, junk food industry is also gradually being excluded nowadays.

Exclusions is suitable for investors who can clearly identify which companies and industries are controversial to ESG factors. What they need to do is to exclude such companies and industries from their investment portfolio. The rest of the investment strategy remains as usual.

2. Impact

Impact is an approach to proactively invest in companies and industries which have beneficial impact on ESG factors. Common investment under this approach includes clean energy and healthy food. Achieving return is still an objective for this approach, so it does not invest in pure charity.

Impact is suitable for investors who wish to make a more significant influence on ESG factors. When working out investment strategy, they need to analyse environmental, social, governance and financial indicators concurrently, to make sure the targets of beneficial impact on ESG factors and investment return can be achieved at the same time.

3. Integration

Integration is an approach to integrate ESG factors into financial valuation and portfolio asset allocation process. In the field of financial analysis, there is an existing valuation and asset allocation system. This approach is to add in the consideration on ESG factors to the existing system. For example, when an analyst values the equity of a company, if the company has a negative impact on environment or society, or it lacks governance ability, the analyst should lower its valuation. When a portfolio manager considers the asset allocation into a specific industry, if the positive impact to environment or society of this industry enhances its potential to bring in better return, the portfolio manager should overweight its asset allocation compared with the benchmark.

Integration is suitable for investors who intend to use ESG factors to optimize their existing investment strategy. They believe that integrating ESG factors into financial analysis can help them make a more informative investment decision.

The three ESG investment approaches can also be mixed and applied together. Especially for Impact, its investment usually concentrates in a few numbers of companies or industries, which lacks diversification. As a result, it is commonly mixed with Integration.

That is all for the basics of ESG investment. If you have any relevant questions, welcome contacting me directly for a discussion.



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