An Introduction to ESG Investing

What is ESG Investing?

Participants in our latest challenge are competing to see if ESG factors improve the ability of a model to predict long term upswings in a companies valuation. See the competition here.

ESG investing is a type of responsible investing that is gaining a lot of traction as it purports to be good, not just for investors consciences, but also their balance sheets. ‘ESG’ refers to Environmental, Social and Governance filings in which companies are required to make disclosures on their performance on each of these topics. Some of the areas included in each topic are listed below.

Environmental

• Climate change policy
• Greenhouse gas emission goals
• Water-related issues
• Recycling policies
• Green products

Social

• Employee treatment
• Employee training/churn
• Ethical supply chain sourcing
• Customer service and customer relations
• Public stance on social justice issues

Governance

• Executive compensation, bonuses and perks
• Factors that decide compensation (short term vs long term incentives)
• Voting structure
• Board structure (e.g. is CEO and Chairman same role?)
• Transparency

Analysts will then take these reports and generate scores for each company on these facets and any sub-factors they believe will contribute to the overall score. These are then combined to create overall facet and total ESG scores. This scoring is done independently by many analysts/agencies and there is a wide range of methodologies because of this. Although we are not using their scores in our competition, Refinitiv have a detailed guide into how they create and structure these scores: See the image below for an overview and click here for a more detailed breakdown.

How does it work?

General Principles

The general reasoning initially behind ESG investing was that companies who score highly on these factors (and thus care about these things) would be more focused on long term value, as opposed to short term boosts in valuation. This, in turn, would allow those companies to attract better talent, retain those staff, build a loyal customer base, mitigate reputational risk and benefit from strong and stable oversight.

Furthermore, in order to achieve these objectives, a company must commit to them in the long term and maintain focus in that direction. This further reinforces the belief that companies with good ESG practices will make good long term investments.

Evidence of a Link to Performance

There is a large and growing body of research and reports (anecdotal and scientific) to show that ESG investing really is superior to investing in fundamentals alone…

To read this full article please go to our forums where this was originally posted: https://auquan.com/community/eic/what-is-esg-investing-and-does-it-work/#post-25

If you’re interested in the competition mentioned in this article you can find more information here: https://quant-quest.auquan.com/competitions/ethical-investing-challenge1