ESG investing: What it is and how it works

Environmental, social and governance (ESG) investing has rapidly grown in popularity in recent years, according to the Securities and Exchange Commission (SEC). 

So who decides what qualifies as an ESG investment? What kinds of issues does ESG investing cover? And how does ESG investing actually work? 

Key takeaways

• ESG investment strategies consider more than just traditional financial indicators.
• The three pillars of ESG investing are related to environmental, social and corporate governance issues.
• ESG investors may focus on one pillar of ESG or look for investments that cover multiple pillars. 
• ESG scores are a way to measure a company’s commitment to ESG issues. But there’s no universal ESG scoring system. 
• ESG investing is sometimes called socially responsible investing (SRI), sustainable investing or impact investing. 

ESG stands for environmental, social and governance. In this context, governance refers to corporate governance.

ESG investing describes a way to screen and guide investment decisions based on those issues instead of only looking at traditional financial indicators. It can apply to investing in individual companies, mutual funds and exchange-traded funds (ETFs).

So when choosing what to invest in, investors might consider a company’s or fund’s dedication to one or more ESG issues. 

ESG investing can be a way to use investments to support—and even influence—companies that are committed to effecting positive change or minimizing negative effects on society or the environment. It can also be a way to weave personal values and causes into investment decisions.

ESG investing takes into account these three pillars:

The environmental aspect of ESG investing looks at companies’ impact on the environment. Some environmental considerations may include: 

• Energy consumption 
• Pollution output
• Carbon emissions
• Waste management
• Water conservation
• Animal welfare

The social part of ESG investing focuses on how a company interacts with people and society. Here are a few examples of social issues an investor might examine: 

• Human rights 
• Employee and labor relations 
• Discrimination issues
• Community investment 

The corporate governance facet of ESG investing evaluates how a company is run. Some governance issues may include:

• Political contributions and lobbying 
• Executive compensation
• Shareholders’ rights
• Transparency 

ESG scores are a way to measure a company’s commitment to environmental, social and corporate governance issues.

It’s important to note that there’s no universal ESG scoring system. Individual investors and private investment companies may each use their own scoring system and criteria. Or they might rely on scores from third-party analysts. 

Because there are so many different ways to calculate ESG scores, a company’s ESG score can vary significantly depending on where it comes from. Plus, some information used in ESG scoring may be subjective. So who’s calculating the score and what they value will impact ESG scores.

Investors can find more information about how a fund analyzes and integrates ESG criteria in the fund’s disclosure documents. 

ESG investing can apply to individual stocks as well as mutual funds and ETFs. And it can be done individually or by working with a broker or robo-advisor.

Investors can buy stock in individual companies that align with their personal preferences about ESG criteria. 

When vetting possible stock investments, the SEC recommends reading up on a given company or fund. That might include the prospectus, any financial reports, shareholder reports, reports on ESG factors and ESG scores. 

A prospectus is an SEC-required document that provides details about a stock or mutual fund to help inform investors. You can find a company’s prospectus through the SEC’s database. And you can also find many reports on the SEC’s EDGAR database, too. 

Mutual funds and ETFs are both investment portfolios that consist of multiple securities, like stocks and bonds. And ESG mutual funds and ETFs are made up of investments that meet that specific fund’s ESG threshold. 

Not all ESG funds use the same vetting process, so ESG criteria and focus areas vary. For example, one fund may focus more on environmental impact, while another might center social or corporate governance issues. Or a fund might incorporate multiple ESG pillars into its investment strategy. 

You can find information on funds using the SEC databases mentioned above and by doing additional research to choose funds that align with your values and risk preference.  

Here are the answers to a couple of frequently asked questions about ESG investments:

ESG investing is an investment strategy that factors in a company’s environmental, social and corporate governance policies. With ESG investing, people can work to align their investments with their values. 

Just like any kind of investing, ESG investing involves risk. And it’s important to do the research and determine your risk preference and financial goals before making any decisions. 

And if you’re new to investing, check out these 10 tips on building wealth.