ESG Investing: Environmental, Social, and Governance Factors in Portfolio Construction

Traditional investing evaluates companies based on financial metrics such as revenue, profitability, and growth potential. ESG Investing adds environmental, social, and governance factors to this analysis, creating a different framework for evaluating investments.

ESG investing has grown from a niche strategy to a mainstream approach, with over $30 trillion in assets globally applying ESG criteria as of 2022. The approach attracts investors seeking to incorporate non-financial factors into their investment decisions, though debate continues about its effectiveness, consistency, and impact on returns.

Understanding ESG: The Three Pillars

ESG stands for Environmental, Social, and Governance—three broad categories that help investors evaluate companies beyond traditional financial metrics.

Environmental (E)

The Environmental pillar examines how a company performs as a steward of nature. This includes:

  • Climate change impact: Carbon emissions, greenhouse gas reduction targets, climate risk management
  • Resource use: Water consumption, waste management, recycling programs
  • Renewable energy: Investment in clean energy, energy efficiency initiatives
  • Pollution and toxins: Air and water pollution control, hazardous waste handling
  • Biodiversity: Impact on ecosystems, deforestation policies

Example: A manufacturing company that invests in solar panels for its facilities, implements water recycling systems, and commits to carbon neutrality by 2030 would score well on environmental criteria.

Social (S)

The Social pillar looks at how a company manages relationships with employees, suppliers, customers, and communities. Key factors include:

  • Labor practices: Fair wages, working conditions, employee health and safety
  • Diversity and inclusion: Board diversity, gender pay equity, inclusive hiring practices
  • Human rights: Supply chain labor standards, anti-discrimination policies
  • Product safety: Quality control, consumer protection, data privacy
  • Community relations: Charitable giving, local economic impact, stakeholder engagement

Example: A tech company that maintains diverse leadership, offers competitive benefits, ensures supply chain workers receive fair wages, and protects user data demonstrates strong social performance.

Governance (G)

The Governance pillar evaluates how a company is led and managed. This includes:

  • Board composition: Independence, diversity, expertise, term limits
  • Executive compensation: Pay linked to long-term performance, reasonable ratios to employee pay
  • Shareholder rights: Voting rights, proxy access, anti-takeover provisions
  • Transparency: Financial reporting quality, ESG disclosure, audit practices
  • Ethics: Anti-corruption policies, whistleblower protection, regulatory compliance

Example: A corporation with an independent board, transparent executive pay tied to sustainability goals, and strong exemplifies good governance.