ESG investing is best defined as an investment strategy considering environmental, social, and governance factors to achieve sustainable, long-term returns. For startups, ESG investing presents an opportunity to do good and make money.
What is ESG investing?
Traditional forms of ESG investing take a negative screening approach, meaning they avoid investments in companies that operate in environmentally or socially harmful industries. More recently, however, many investors have adopted a positive or best-in-class approach to ESG investing. This means they proactively seek out companies that are leaders in environmental, social, and governance practices.
There are several benefits associated with ESG investing. One is that it can help to mitigate risk. Traditional financial analysis often undervalues environmental and social risks. By considering these factors, investors can better understand the dangers a company faces and make more informed investment decisions.
Why does environmental, social, and governance (ESG) investment matter?
Environmental, social, and governance (ESG) investments are essential for several reasons.
- An increasing number of investors are interested in making investments that positively impact the world. These investors want to know that their money is being used to support companies working to make a difference, whether by helping to protect the environment or improve social welfare.
- ESG investing can help to mitigate risk. Many traditional financial analysis tools undervalue environmental and social risks. By considering these factors in your investment decision-making process, you can better understand the company’s actual risks and make more informed investment decisions.
- ESG investing can lead to superior financial returns. A growing body of academic research has shown that companies with substantial environmental, social, and governance practices tend to outperform their peers over the long term.
How to invest in ESG
The first step for any startup looking to implement an ESG investing strategy is to assess which environmental, social, and governance factors are most relevant to their business.
For example, a company that manufactures solar panels would likely consider environmental factors such as greenhouse gas emissions and water use. In contrast, a company focusing on employee wellness might consider social factors such as diversity and inclusion. A company looking to build a sustainable business model might consider governance factors such as board diversity and executive compensation.
Once the most relevant ESG factors have been identified, the next step is integrating them into the investment processes. Investors can do this in several ways, but common approaches include:
- Screening investments for ESG compliance.
- Incorporating ESG criteria into investment decision-making.
- Engaging with portfolio companies on ESG issues.
Picking the right company to invest in
Screening investments for ESG compliance is a relatively straightforward way to integrate ESG into the investment process. This can be done using negative screening, which involves excluding companies from the portfolio that do not meet specific ESG criteria. For example, a negative screen might exclude companies involved in producing fossil fuels or with below-average scores on environmental, social, and governance metrics.
Incorporating ESG criteria into investment decision-making is a more active approach to integrating ESG into the investment process. This involves considering environmental, social, and governance factors alongside financial considerations when making investment decisions. As mentioned above, an investor might choose to invest in a company because it has strong environmental policies or a diverse and inclusive workforce.
Engaging with portfolio companies on ESG issues is another way to integrate ESG into the investment process. This involves working with companies in the portfolio to improve their ESG practices.
Integrating ESG into the investment process can be challenging, but many resources are available to help investors get started. The Sustainable Investments Institute (SII) offers a range of resources on ESG investing, including a database of ESG-screened investments and a guide to integrating ESG into the investment process.
Other helpful resources include the GreenBiz Group’s ESG Investing Hub and the Investor Responsibility Research Center Institute’s (IRRCi) ESG Resources for Investors.
Limitations of ESG investment
There are several limitations of ESG investment, such as the lack of standardization, data availability, and difficulty measuring some environmental, social, and governance factors.
The lack of standardization is a significant limitation of ESG investment. There is no single definition of an ESG-friendly investment, making it difficult to compare different investments and assess their ESG credentials. This problem is compounded by the fact that there is no universally accepted set of environmental, social, and governance criteria. As a result, different companies use different criteria to assess ESG compliance, which makes it difficult to compare apples to apples.
Data availability is another limitation of ESG investing. While there is a growing body of data on environmental, social, and governance indicators, finding reliable and up-to-date data on some ESG factors can be difficult. This problem is compounded by the fact that many companies do not disclose their ESG data publicly.
The difficulty in measuring some environmental, social, and governance factors is also a limitation of ESG investing. Many of the most critical ESG indicators, such as greenhouse gas emissions or employee satisfaction, are not easily quantifiable. As a result, it can be challenging to assess a company’s ESG performance and compare it to other companies.
Despite these limitations, a growing body of evidence suggests ESG investing can be successful. A recent study by MSCI found that companies with substantial environmental, social, and governance practices outperformed their peers on various financial metrics, including return on equity, earnings growth, and dividend yield.
ESG vs. Impact investing
ESG differs from Impact investing in several ways:
1. ESG investing is a more passive approach to integrating environmental, social, and governance considerations into the investment process, while Impact investing takes a more active approach.
2. ESG investing focuses on incorporating environmental, social, and governance factors into investment decision-making, while Impact investing focuses on investments with a positive environmental or social impact.
3. ESG investing involves considering environmental, social, and governance factors alongside financial considerations when making investment decisions, while Impact investing typically gives equal weight to economic and impact considerations.
4. ESG investing involves engagement with portfolio companies on ESG issues, while Impact investing generally does not.
5. Finally, ESG investing can be used in conjunction with any investment strategy, while Impact investing is typically used in conjunction with a positive screening strategy.
Despite these differences, ESG and Impact investing share many commonalities. Both approaches seek to address environmental and social issues through the investment process. Both methods are based on the premise that environmental, social, and governance factors can negatively impact financial performance. In addition, both approaches are experiencing rapid growth as investors increasingly seek opportunities to invest in companies that are positively impacting the world.
What are the advantages of ESG investing for startups?
As of December 2021, global exchange-traded “sustainable” funds that make environmental, social, and governance (ESG) investment promises had assets under management totaling more than $2.7 trillion. HBR states that 81 percent were invested in European-based vehicles, while 13% were invested in American-based vehicles. In the fourth quarter of 2021 alone, $24.6 billion was contributed to such funds.
The advantages of ESG investing for startups include:
- Alignment with company values: ESG investing allows startups to invest in line with their values, which can help attract and retain employees who share those values.
- Access to capital: ESG investors are often willing to provide patient capital, which can be critical for early-stage companies.
- Positive publicity: Investing in accordance with ESG principles can generate positive publicity for a startup, helping to build its brand and reputation.
- Enhanced risk management: Incorporating ESG factors into investment decision-making can help startups identify and manage risks more effectively.
- Improved financial performance: Research suggests that companies with strong ESG practices tend to outperform those without them, providing a financial incentive for startups to adopt such practices.
ESG investing can provide significant advantages for startups, helping them to attract capital, build their brand, and improve their financial performance. By aligning their investments with their values, startups can also improve employee morale and retention.
Increased investment
ESG investing started to gain traction in the 1990s as more investors began to consider environmental, social, and governance issues when making investment decisions. In recent years, investment in ESG funds has increased dramatically as more and more institutional investors allocate a portion of their portfolios to these types of investments.
Another reason for the increased interest in ESG investing is the growing awareness of climate change’s impact on our planet. As the effects of climate change become more evident, investors are looking for ways to invest in companies that are taking steps to mitigate these effects.
Reputation Boost
In addition to the financial benefits, investing in ESG funds can also help boost a company’s reputation. As more and more consumers become aware of the importance of environmental, social, and governance issues, they are increasingly likely to do business with companies considering these issues.
By investing in an ESG fund, companies can signal to their customers and other stakeholders that they are committed to positively impacting society. This can help create goodwill and brand loyalty, increasing sales and profits.
Why ESG’s are more crucial than ever before
A recent study by Statista states that “Covid-19 and investment behavior worldwide,” leaving no industries unaffected – including the investment industry. In March 2020, all major financial markets worldwide saw sharp declines, with several implications on the behavior of many investors. While many of these impacts could be considered harmful, one area where a larger share of investors assumed positive outcomes from COVID-19 was environmental, social, and governance (ESG) issues.
The positive effects are believed to be a more substantial consideration of ESG issues, reconsiderations of ESG issues, and to think of it as more important than before (especially the social component).
As awareness of environmental, social, and governance issues continues to grow, so will investment in ESG funds. This increase in interest and investment can help spur companies to take more significant action on these crucial issues, leading to a more sustainable future for us all.
Risk mitigation
Risk can be mitigated in 5 steps when investing in ESG companies including:
1. Diversify: By investing in a mix of companies across different industries and countries, you can reduce the risk that any one event will impact your portfolio. Diversification also allows you to take advantage of other growth opportunities in different parts of the world & market.
2. Research: It is essential to do your research when investing in any company, but it is imperative with ESG companies. Ensure you understand the issues important to the company and how they address them. This research should include reading the company’s annual report and talking to management about proper due diligence in all company areas.
3. Consider different types of risk: When evaluating an ESG company, it is crucial to consider the many dangers of investing. These risks include environmental hazards, including exposure to climate change or regulatory changes, social risks, employee relations or customer satisfaction, and governance risks, such as board composition or executive compensation.
4. Integrate ESG into your investment process: Make sure you consider ESG factors when making investment decisions. This includes incorporating ESG data into your analysis and using it to make buy/sell decisions.
5. Monitor your investments: Once you have invested in an ESG company, it is vital to monitor it on an ongoing basis. Good traceability metrics include the level of disclosure, progress on specific goals, and the overall engagement of management with stakeholders.
Sustainable and Responsible Investing (SRI)
The terms “sustainable” and “responsible” investing are often used interchangeably, but there are some subtle differences between the two.
Sustainable investing focuses on investments that seek to generate positive environmental or social impact alongside a financial return. This investing often targets companies working to solve pressing global challenges, such as climate change or access to clean water.
On the other hand, responsible investing considers a broader range of environmental, social, and governance factors when making investment decisions. This includes issues like employee relations, board diversity, and carbon emissions.
While both sustainable and responsible investing have the same goal of generating positive social or environmental impact, responsible investing takes a more holistic approach to evaluate companies. When you invest in an ESG company, you are not only considering the financial return of your investment but also the positive impact the company is having on environmental or social issues.
Overall, “sustainable and responsible investing” (SRI) describes investments that seek to generate both financial return and positive social and environmental impact. While there is no single definition of SRI, the term generally encompasses a broad range of investment strategies that consider environmental, social, and governance (ESG) factors and financial considerations.
Final Thoughts
ESG investing is sustainable and responsible investing that considers environmental, social, and governance factors when making investment decisions. This investing often targets companies working to solve pressing global challenges, such as climate change or access to clean water. While ESG investing does have the potential to generate a financial return, it is vital to consider the risks associated with this type of investment. These risks include environmental hazards, social risks, and governance risks. Once you have invested in an ESG company, it is essential to monitor it on an ongoing basis to ensure it has the intended impact.
ESG investing is a rapidly growing area of the investment world. M Accelerator has the resources and expertise to help startups and companies interested in this investing get a foothold in the market. With programs and cohorts specifically designed for ESG investing, we have the tools and knowledge to help companies succeed in this rapidly growing area.
Additionally, our extensive network of investors and ESG experts can provide the support needed to navigate this complex and ever-changing market. Whether you’re a startup looking to enter the ESG investing space or an established company looking to expand your portfolio, Maccelerator can help you achieve your goals.
For more information, please visit our website to get involved!
