You have definitely head the term by now: ESG (Environmental, Social and Corporate Governance). It’s the next big checkbox PE is looking to tick off in investments, and the standards upon which companies will increasingly base their corporate values.
ESG constitutes a range of criteria used by investors to evaluate a company/firm’s commitment to ensuring its sustainability, the wellbeing of its people, and its compliance with corporate regulation. These metrics are often non-financial in nature and can comprise a wide range of business activities.
ESG is a big trend that will continue to be part of a corporate structure as its importance continues to grow within the newer generation of investors.
But a vital question remains: what makes a good ESG business? ESG investing is measured on ESG scores – this concept is very new and a standard has yet to be placed. Some investment firms have stepped into this void to provide ESG scores for companies, such as MSCI and Sustainalytics.
The following article from US News does a good job of explaining on how ESG rating and scores are based on. Here are some highlights below:
According to the article, “an ESG score is a rating that evaluates how sustainably a company is conducting business.” The scores are based on two factors: risk/opportunity exposure and performance.
An investor would look at an ESG score because they want to see if a company’s values are aligned with their own or to see if a company is sufficiently shielded from future risks associated with issues such as pollution or poor corporate governance.
According to the article, there isn’t a set standard. ESG scores are calculated by companies that use their own formulas and methods to quantify and measure how well publicly traded companies are meeting ESG metrics.
MSCI, for example, collects publicly available data relevant to a company’s exposure to industry-specific risks such as business activities, size of its operations and where it operates; assigns percentage weights to ESG risks; and compares a company to industry peers to get the ESG rating from AAA to CCC.
Because there is no set standard, it depends on which rating score you’re looking at. According to the article, an MSCI rating of AAA represents a company managing its ESG issues particularly well. Sustainalytics, another major provider of ESG scores, can range from 0 to 40+, with 0 representing the lowest level of risk. Ultimately, the best rating by these agencies would mean the same thing: that a company is able to manage its ESG risks effectively and is a leader among its peers.
ESG is not a strong indicator of market performance, but rather a comparison of ESG values between a group companies. Companies that don’t manage ESG risks well could post market gains, and it can be equally true that companies with high ESG scores may underperform.
The article states that the jury is still out on whether higher ESG scores will lead to higher investment returns, however, there are merits to investing with an ESG approach that may help investors identify valuable long-term investments.
ESG is a trend that we have noticed with our clients in the consulting, technology, and business services industries.
If you want to get in touch about anything ESG related, don’t hesitate to do so. With the rapid demand in this space, this could be a good time to explore your options for raising funding or securing a valuable exit. Like always, if you have any interest, please reach out!
It may not be enough for companies to make profits anymore. An increasing number of investors are incorporating their values into their long-term investing strategies through the lens of environmental, social and governance concerns, or ESG investing.