ESG is currently the hottest topic in business. But if you live your life outside of Fortune 500 finance organizations (i.e. the majority of the world…), the actual meaning of the acronym, ESG, might escape you. So what does ESG stand for? ESG stands for environmental, social, and governance and is both an investing strategy and an overall business strategy. The idea is the inclusion of good corporate citizenship into organizations that have traditionally been vehicles solely focused on financial returns.
Global ESG strategy can take many forms. Geographically, Europe is leading the pack with top-down regulation from the government. Meanwhile, here in the US, we’re still very reliant on companies volunteering information on their ESG strategies and results..
This means that each company basically gets to define ESG standards for itself. Making answering the question of “what does ESG stand for?” pretty complex. However, the drive for our corporations to be better global citizens will only increase, so getting some answers now is key. In the following article, I’ll explain what environmental, social, and governance mean as individual strategies and explain what this could mean for your investments.
What Does ESG Stand For? The Story of “E”
The “E” in ESG, or “environment” is probably the part of ESG investing strategy that is getting the most attention these days. It’s easy to see “environmental” and “investing” in the same sentence and immediately think of green energy.
Indeed, those technologies are a piece of the pie, but the “E” in ESG extends far beyond wind and solar companies. From deforestation to waste management, considering environmental factors in your investing strategy is both good for the planet and just smart business.
While the good for the planet part is easy to see, the smart business comment might not seem so simple. Traditionally, transitions to environmentally friendly business are seen as a result of regulation, and adhering to regulatory standards is costly.
While I’m all for the government stepping in and regulating business in order to care for the one planet that we have, I do see plenty of ways in which costs can be reduced or revenue increased through green initiatives.
How Green is Good for Bottom Lines
One example of the cross-section between environmental strategy meeting the bottom line is energy efficiency. Energy costs can be major line items for overhead costs for businesses. By implementing efficiency measures, such as smart thermostats, new, energy-efficient machinery, or just simply turning off the lights, businesses can save plenty of money.
This may seem simplistic, but Mckinsey reports that operating budgets can be cut by 60% by employing sustainable strategies instead of traditional ones.
There is also plenty of revenue to be earned by going green. 77% of consumers consider environmental impact in the purchases they make, giving environmentally friendly companies a leg up on the competition.
Finally, it’s pretty clear that we’re moving towards a more sustainable future globally. This opens the door to risk in industries that can’t come along for that ride. Asset managers, globally, are divesting from fossil fuels. These industries are just not that likely to maintain current valuations, nonetheless growth, as we move forward. This makes companies that don’t pass ESG muster, potentially riskier, more volatile investments.
What Does ESG Stand For? The Story of “S”
Ah the “S”, or “social” in ESG, something I recently read was referred to as the difficult middle child of the popular “E” and more mature “G”. This is because social factors are extremely tough to quantify.
The “S” covers so many difficult topics – pay equity, diversity, inclusion, human rights, data privacy and protection, employee engagement, and labor rights, just to name a few. Each of these alone, with perhaps the exception of pay equity, can be difficult to measure success. Throw them under a single umbrella, add cultural and legal differences that span the globe, and well… you get the idea.
The interesting thing about social factors in global ESG strategy is that there is an incredible amount of research, and sometimes just common sense to back up the idea that doing good (socially) really does mean doing well (financially).
How Social Wellness is Good for Bottom Lines
I used to be a die-hard fan of Fabletics yoga pants. They introduced me to the yoga pant with the pocket concept, and I just couldn’t get enough. Then I read that there were (alleged) human rights abuses against women working in their main factory in Lesotho. Since then I have never bought another pair.
It’s easy to see how companies can quickly spiral downwards if they forego prioritizing social issues.
This rings true for data privacy and protection issues as well. It’s estimated that Target lost $200M in their data breach and currently women are running, not walking, away from period tracking apps in fear of access to their very private data, in this post-Roe world.
Finally, companies with diverse and inclusive workforces, both by gender and ethnicity, regularly outperform their more traditional counterparts. This article has some great stats if you want to read more.
Clearly, companies should consider social wellness, but as investors, the above examples illustrate why it’s important to have a social lens in our investments. Without it, we could potentially expose ourselves to companies with high-risk profiles, and lose out on opportunities for growth.
What Does ESG Stand For? The Story of “G”
To answer “what does ESG stand for?” It’s important to get the “G”, or “governance” down. Earlier I reference governance as the mature older sibling of ESG. That is because good corporate governance has been around for much longer than the integration of environmental and social issues into business strategy.
The “G” is ESG mainly deals with leadership oversight – internal audits, external audits, disclosures, etc. While much of this is a bit in the weeds for the average investor, the thing to note is that without good governance you cannot have good sustainability or social wellness within a corporation.
There is a saying in South America – from the head moves everything. If leadership in a company is not adhering to best practices for governance, then everything below them falls prey to bad policy. In addition, there are issues that are coming to the forefront that fall under the governance category and are extremely important to be able to have line of sight into as we progress to a more conscious corporate world.
Newer Concepts in Good Corporate Governance
With ESG investing taking hold in the mainstream, issues that have been growing concerns to the populace are starting to make their way into considerations for how investment dollars are spent. Some that are top of mind, and that I personally can’t wait to see companies taken to task for are:
- Executive pay: currently the gap between CEO pay and the median worker is 235:1. The pandemic has highlighted the risk that these pay gaps can create as we see front-line workers leaving low-paying service jobs and the current worker shortage. Not to mention, paying a CEO tens of millions of dollars while workers aren’t even making a living wage is just plain bullshit.
- Lobbying: Over $30B is spent in the United States every year on corporate lobbying. What interests and policies are being pushed by which companies is about as clear as mud. A quick Google search on my end to see which companies lobbied against Medicare for all or for anti-abortion legislation returned all of nothing.
- Political Donations: Imagine a United States without corporate influence on campaign budgets. I’d hazard a guess that we’d be able to eliminate healthcare debt, move away from fossil fuels, and possibly even be able to cater to the majority of Americans seeking reasonable gun control. While information can be accessible on which corporations donate to which candidates, this can be obscured when the money is funneled through third parties. At the same time – do we really want corporations to donate at all?
It might seem a bit pie in the sky to say that doing good can mean doing well, but frankly, the two go hand in hand. As individual investors, we don’t have to make the choice between our values and building a nest egg.
So what DOES ESG stand for? It’s is paving the road for us to build our investment portfolios in a way that builds a brighter future for us as individuals and for the greater good.
Now, if the government could just catch up and add in some regulation, we’d be on our way.