Understanding ESG Investing: 9 Terms You Should Know

The numbers speak for themselves: more and more investors want their investments to contribute to a better world. Whether you’re among the 79% of Canadians already considering investing in companies that adhere to environmental, social and governance (ESG) values, or you simply want to learn about responsible investing, the basic concepts can be a good gateway. In the following text, we present nine key terms related to ESG investing and their definitions.

ESG: An acronym used to describe environmental, social and governance, three elements that help investors assess ESG-related risks and opportunities. Taking these elements into account in the investment approach is called the integration of ESG criteria.

Environmental criteria focus on companies’ environmental stewardship, while social criteria focus on, for example, companies’ relationships with their employees, customers and communities. Governance examines corporate policies in areas such as executive compensation, gender diversity on boards and board independence.

Responsible Investment (RI): A general term used to refer to a wide range of investment approaches that integrate ESG criteria. Responsible investing, sometimes also called “ESG investing” or “sustainable investing”, includes three investment strategies: integration of ESG criteria, socially responsible investing (SRI) and impact investing.

Socially Responsible Investments (SRI): The practice of investing in companies and funds that have a positive impact on society. To do this, pre-selection is often done based on a predetermined set of values. Negative pre-selection excludes companies that have an adverse impact on society – think of companies in the tobacco sector or those whose activities are considered polluting – while positive pre-selection preserves companies whose practices, products or services bring about a better world.

Impact investing: A subset of ESG investing, impact investing prioritizes measurable and beneficial changes to society or the environment that companies, organizations or funds create. Proponents of impact investing are not only aiming for financial return, but also other goals.

Greenwashing: False or misleading claims about a product or company to exaggerate its environmental responsibility. Greenwashing is a growing problem as ESG criteria gain popularity.

Sometimes it’s hard to recognize. This is why investors can benefit from taking due diligence measures such as checking the prospectus rather than relying solely on a marketing leaflet and checking that a company’s goals are actually included in its sustainability plan rather than taking them for granted.

Conscious Capitalism: A philosophy advocated by Raj Sisodia, professor of marketing, and John Mackey, co-founder of Whole Foods, that companies must act ethically and in the interests of all stakeholders, not just management and shareholders, in pursuit of profit.

The philosophy is built on four main principles:

  1. Higher mission: A company must have other reasons for existence than just making a profit.
  2. Concern for stakeholders: It is necessary to align the needs of all stakeholders, from employees and customers to suppliers and investors.
  3. Conscious Leadership: Leaders must embrace and serve the company’s mission.
  4. Conscious Culture: Leaders must be intentional about creating a culture that supports the company’s values ​​and mission.

ESG rating: Means used to evaluate a company’s ESG practices. Several organizations provide ESG ratings, most of which can be viewed online. MSCI ESG, currently an influential company in this market, ranks potential investments on a scale from AAA (leaders) to CCC (laggards). It is important to know that the parameters for evaluating companies are not yet standardized and the way ESG criteria are evaluated may differ between organizations.

In November 2021, following industry consultation, CFA Institute published the first voluntary ESG disclosure standards for investment products. The organization hopes that these standards will soon be widely adopted by fund companies around the world.

ESG reporting standards: A set of information about the company, the timely disclosure of which can influence investment decisions. By applying these standards, investors would have full knowledge of ESG issues related to companies’ objectives as well as their investment processes and stewardship activities.

Clearance: The act of selling or avoiding investing in companies, sectors or countries because of certain activities. For example, investors who want to fight climate change could avoid investing in industries that have a high carbon footprint.

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