ESG stands for Environmental, Social, and Governance. It is a set of criteria that investors and companies use to evaluate a company's sustainability and societal impact. In recent years, ESG has become increasingly popular as investors have become more concerned about the environmental and social impact of their investments. In this article, we will explore what ESG is, why it is important, and how it is used.

What is ESG?

ESG refers to a set of criteria that investors use to evaluate companies based on their environmental, social, and governance practices. Environmental factors include a company's impact on the natural environment, such as its carbon emissions and water usage. Social factors include the company's impact on society, such as its labor practices, diversity and inclusion policies, and community engagement. Governance factors include the company's leadership structure, board composition, and executive compensation.

Why is ESG important?

ESG is important because it provides a framework for evaluating a company's impact on the world beyond just its financial performance. In today's world, investors are increasingly concerned about the social and environmental impact of the companies they invest in. Companies that have strong ESG practices are more likely to be sustainable in the long term and are less likely to face legal or reputational risks. ESG can also help companies attract and retain customers, employees, and investors who value sustainability and social responsibility.

Here are some numbers that highlight the importance of ESG: 

1. Investor Demand:

   Despite a recent decline in new investments, inflows into sustainable funds have seen a significant increase, going from $5 billion in 2018 to over $50 billion in 2020, and nearly $70 billion in 2021. In the first quarter of 2022, these funds received $87 billion of net new money, followed by $33 billion in the second quarter. As of mid-2022, global sustainable assets amount to approximately $2.5 trillion. While there was a 13.3% decrease from the end of Q1 2022, it is still less than the 14.6% decline observed in the broader market during the same period. Additionally, studies have shown that 86% of institutional investors believe that sustainable investing leads to higher financial returns.

   
   

2. Reduced Costs:

   Implementing ESG effectively offers various benefits, including the ability to address increasing operating expenses. Research has indicated that rising costs, such as those related to raw materials and the actual cost of water or carbon, can significantly impact operating profits, potentially reducing them by up to 60%. By incorporating ESG practices, companies can mitigate these expenses and safeguard their operating profits.

   
   

3. Higher Performance:  

   A strong ESG position can help attract and retain top employees, increase motivation by providing a sense of purpose, and improve overall productivity. Research shows that companies listed on Fortune's "100 Best Companies to Work For" have generated 2.3% to 3.8% higher stock returns per year than their peers over a 25-year period. Employee satisfaction is positively correlated with shareholder returns.

On the other hand, a weak ESG proposition can have negative effects on productivity. Labor actions, strikes, and supply chain issues can hinder performance. Companies with a focus on ESG take steps to ensure sustainability across their value chains and monitor supplier work conditions.

How is ESG used?

ESG is used in a variety of ways. For investors, ESG criteria are used to evaluate companies for investment purposes. Some investors use ESG as a way to avoid companies that have a negative impact on the environment or society, while others use ESG to identify companies that are leaders in sustainability and social responsibility. ESG is also used by companies to evaluate their own practices and identify areas for improvement. Many companies now issue sustainability reports that detail their ESG practices and goals.

Conclusion

ESG is a set of criteria that investors and companies use to evaluate a company's sustainability and societal impact. It is an important framework for evaluating companies beyond just their financial performance. Companies that have strong ESG practices are more likely to be sustainable in the long term and are less likely to face legal or reputational risks. ESG is an important tool for investors who are concerned about the social and environmental impact of the companies they invest in. As the world becomes more focused on sustainability and social responsibility, ESG is likely to become even more important in the years to come.