ESG Investing For Dummies

Brendan Bradley is co-author of FinTech For Dummies. He fosters and develops support for new ­investment areas, including AI-assisted research for automated modeling and transforming ­unstructured financial content in the ESG ecosystem.

Introduction 1

About This Book 1

Foolish Assumptions 2

Icons Used in This Book 3

Beyond the Book 3

Where to Go from Here 3

Part 1: Getting to Know ESG 5

Chapter 1: Entering the World of ESG Investing 7

Surveying the Current ESG Landscape 8

Exploring What ESG Is (and Isn’t) 9

Defining the breadth of ESG 10

Comparing SRI, ethical, and impact investing to ESG 14

Determining whether ESG delivers good investment performance 16

Understanding ESG’s Impact on the Environment, Society, and Governance 17

Meeting environmental and global warming targets 17

Providing solutions to social challenges 18

Meeting corporate governance requirements 18

Using International Standards to Determine ESG Objectives 19

Leading the charge: European legislation on ESG 20

Ahead of its time: The United Nations 21

Staying focused: The Sustainability Accounting Standards Board 21

Building a framework: The Global Reporting Initiative 22

Chapter 2: Back to the Future: Understanding the Evolution and Growth of ESG Investing 23

Studying the Evolution of Investing in ESG 24

Investing through the ages: From SRI to ESG 24

Go green: The changing global environment 27

On trend: Changing investor demographics 28

Crunch the numbers: Evolving data and analytics 29

Exploring the “Personality” of an ESG Company 31

Determining material ESG factors 31

Performing a materiality analysis 32

Applying weights to materiality measures 33

Understanding Why ESG Is Important 34

Global sustainability challenges 35

The interest of millennial investors in ESG 35

More systematic, quantitative, objective, and financially relevant approaches 36

Surveying Specific ESG Ratings and Metrics 36

Data quality, ratings bias, and standardization 37

Issues with ESG scoring 38

ESG momentum importance 39

Applying artificial intelligence and data science to ESG analysis 39

Defining an ESG Policy 40

Familiarize yourself with ESG and asset owner–specific legislation 40

Undertake a peer review 41

Review your statement of investment beliefs and core investment principles 41

Specify responsible investment guidelines 41

Outline responsible investment procedures 42

Include engagement and active ownership approaches 42

Spell out reporting requirements 43

Chapter 3: Give Me an ‘E’! Defining the Environmental Sector in ESG 45

Outlining a Company’s Use of Natural Resources 46

CO2 or GHG? Climate change and carbon emissions 46

Clean and green: Energy efficiency 48

A crisis awaits: Conservation of water 49

There is no Planet B: Air and water pollution 50

Live and let live: Biodiversity 51

See the forest for the trees: Deforestation 52

Don’t throw your future away: Waste management 54

Studying the Effects of a Company’s Operations on the Environment 55

Direct operations 55

Supply chains 56

Defining “Green” for a Company 57

Internalizing (or managing) externalities 58

The 3Rs: Reduce, reuse, and recycle 58

Detailing a Company’s Performance as a Steward of the Physical Environment 60

Managing operations to reduce emissions and promote sustainability 61

Collaborating with others to create solutions for environmental issues 61

Chapter 4: Give Me an ‘S’! Investigating the Social Aspects of ESG 63

Identifying Factors in a Company’s Social Performance 65

Customer satisfaction 65

Data protection and privacy 66

Gender and diversity 68

Employee engagement 69

Community relations 70

Human rights 71

Labor standards 72

Evaluating a Company’s Social Performance 73

The results are in: Achievements 74

When in Rome: Differentiating on a national or regional basis 75

Determining Measurements for Social Performance 75

The alignment of social and economic responsibilities 76

Long-term change for people and communities 77

Deciding on Weight Factors 78

Take your pick: Different social issues 78

Think outside the box: Scenario analysis 79

Chapter 5: Give Me a ‘G’! Decoding the Governance Component of ESG 83

The Good Place: Defining What “Good” Corporate Governance Looks Like 84

The benefits of good governance 85

Practices and values 86

Multiple stakeholder orientation 87

Walk the Walk: Evaluating a Company’s Governance Values 88

Board responsibilities 89

Board composition 90

Audit committee structure 90

Bribery and corruption 92

Executive compensation 94

Lobbying 95

Political contributions 96

Whistleblower schemes 97

Lead the Way: Emphasizing How ‘G’ Can Dictate the ‘E’ and ‘S’ Factors 98

Governance as an overarching principle for ESG 98

The role of governments 100

Around the World: Underlining Regional Differences in Governance Activities 101

Emerging markets 102

North America 104

Europe 105

Chapter 6: Highlighting Corporate Greenwashing 107

The Grass Isn’t Always Greener: The Basics of Greenwashing 108

Tracking the growth of greenwashing 108

Specifying the details 109

Using plain language 110

Setting up a system 112

Just When You Thought It Was Safe: Coronawashing 113

Coronawashing on the corporate side 113

Coronawashing on the investor side 114

Part 2: Investing in ESG through Different Instruments 117

Chapter 7: Approaches to ESG Investing 119

Understanding Socially Responsible Investing 120

Looking at reasons for SRI 120

Comparing a best-in-class strategy to an exclusion strategy 121

Weighing the potential return on SRI decisions 122

Evaluating Impact Investing 124

Defining and tracking “impact” 124

Measuring social and environmental outcome targets 126

Calculating impact metrics 127

Focusing on Faith-Based Investing 128

Reviewing religious principles of finance 128

Examining exclusion screening and divesting 129

Advocating for values through proxy voting 130

Chapter 8: Analyzing Equity-Based Instruments 133

Integrating ESG Strategies into Investment Decisions 134

Just the basics: Getting an overview of the process 134

Using active strategies 136

Analyzing the impact of different ESG scores 137

Watch out: Thinking about risks and disclosures 138

Investigating how companies with higher ESG scores outperform 139

Take it easy: Applying passive strategies 140

Reviewing relative returns and performance of ESG stocks 143

Verifying Quantitative Strategies 145

Constructing equity portfolios that integrate ESG factors 146

Adjusting stock index constituent weights 148

Determining which ESG factors matter most in quantitative strategies 148

Identifying Smart Beta Strategies 151

Extending negative stock screening to smart beta strategies 153

Using ESG equity factors and scores to weight portfolio construction 153

Focusing on a Given Theme 154

Sector exposure 154

Thematic exposure 155

Chapter 9: ESG and Fixed Income Instruments 157

Analyzing Fixed Income (Bond) Factors 158

The importance of risk 158

Strategies for adding ESG to fixed income portfolios 159

Bond issuer goals 160

Defraying interest rate costs 161

All together now: ESG integration issues 162

Bond pricing 163

Mix it up: Credit and ESG ratings 164

Emphasizing Bond Issuer Differences 165

For king and country: Sovereign issuance 166

Corporate issuance 168

Room for more: Emerging markets 168

Highlighting Fixed Income Indexes 169

Identifying Specific ESG Exposures 171

For the earth: Green bonds 172

Think big: Social bonds 174

Keep it up: Sustainability and sustainability-linked bonds 175

Chapter 10: Exploring Derivative and Alternative Instruments 177

Achieving Passive Returns Using ESG Indexes 178

The basics of exchange-traded products 179

OTC derivatives 180

Building blocks: Structured products 181

Increasing Focus on ESG in Alternative Assets 182

Sustainable lending 182

ESG in hedge funds 184

Focusing on Illiquid Assets 186

Around the block: Real estate 186

Laying foundations: Infrastructure 187

Hush-hush: Private equity 188

Investing in “Traditional” ESG 189

Pull the plug: The basics of renewable energy investment 190

Light my fire: Solar power 191

There she blows: Wind power 192

Chapter 11: Highlighting Geographical Differences in ESG Investing 195

The Beginning: Europe 196

Highlighting the regulatory developments 198

Enjoying a first mover advantage on ESG investment 201

Continuing inflows for ESG funds 202

The Middle: North America 203

Highlighting political and regulatory roadblocks in the United States 204

Investigating Canada’s approach 206

Driving up demand 207

The End: Developed versus Emerging Markets 208

Seeing that emerging markets are lagging but disclosure is increasing 209

Highlighting political and regulatory developments 211

Determining whether an ESG approach is better suited to developed economies 212

Part 3: Applying ESG Philosophy 215

Chapter 12: Creating Value through ESG for Corporations 217

Crystal Clear: Corporate Disclosure and Transparency 218

Meet the team: ESG engagement 219

Thank you for sharing: Communication from the board 221

Grow the Pie: Generating Enhanced Returns 221

Increasing access to capital 222

Corporate adoption and action 223

Roll Up, Roll Up: Attracting More Customers 224

Tracking sustainability practices 225

Measuring intangible value drivers 226

Identifying material opportunities 227

Pare It Back: Reducing Costs 228

Green financing 228

How low can you go? Lower interest rates and higher credit ratings 229

The Bottom Line: Increasing Productivity and Attracting Talent 230

Chapter 13: Devising an ESG Policy 233

Here’s a Great Idea: Creating a Plan 234

Promoting ESG among key stakeholders 235

Creating an internal governance structure 235

Don’t Reinvent the Wheel: Undertaking a Peer Review 236

Devising ESG investment strategies 236

Identifying, assessing, and selecting ESG investments 238

Go Over It: Reviewing Your Core Investment Principles 238

Familiarizing Yourself with ESG-Specific Regulations 240

Comparing Europe and the United States 240

Taking into account sustainability-related risks 241

Doing effective due diligence on ESG greenwashing 242

Surveying Reporting Requirements 243

Essential characteristics of ESG data 244

Material factors for investors 244

Examining ESG Engagement 245

Conducting constructive dialogue on managing ESG risks 245

Seizing business opportunities associated with sustainability challenges 246

Chapter 14: Defining and Measuring ESG Performance and Reporting 249

Defining Criteria and Metrics 250

Follow the rules: Looking at regulators’ work 251

The devil is in the details: Analyzing corporate sustainability reports 252

Walk the walk: Committing to corporate social responsibility practices 253

Show me the money: Identifying investment performance 254

Calculating Relative ESG Performance 255

Against the broader market 257

Against specific benchmarks 258

Getting a Handle on Ratings and Rankings 259

Securities 260

Portfolios 261

Not the sharpest tool: Smart beta 262

Developing Frameworks for Reporting 262

In your view: ESG objectives 263

Play by the rules: ESG compliance 265

Meet the players: Comparing different frameworks 265

Chapter 15: Elaborating the ESG Endgame 269

Highlighting the Evolution of ESG from Niche to Mainstream Strategy 269

Achieving competitive financial returns with positive ESG impact 270

Emphasizing the need for common terminology 271

Watching the Growing Use and Acceptance of ESG Standards 272

Digging into disclosures 272

Providing data consistency 274

Developing national and international financial reporting standards 275

Looking at the Increasing Impact of ESG Ratings and Rankings 278

Qualitative decisions 279

Quantitative decisions 280

Improving Education 281

What do investors believe is important? 282

What should a company know about its ESG rating? 283

Part 4: The Part of Tens 285

Chapter 16: Ten Frequently Asked Questions for an ESG Approach 287

What Is ESG Investing? 287

Which Sustainability Goals Should Be Followed? 288

What Are the Characteristics of an ESG Company? 289

How Is an ESG Company Rated? 290

What Investing Principles Should Be Adopted for ESG? 291

What Is Stewardship? 292

How Is an ESG Approach for Asset Owners Implemented? 293

How Are Benchmarks and Performance Measurement Incorporated in ESG? 293

What’s the Latest on Disclosures and Reporting? 294

What’s the Future of ESG Investing? 295

Chapter 17: Ten Issues Surrounding ESG Portfolio Construction 297

Reasons for Varying ESG Scores between Rating Agencies 297

Criteria Used in Creating a Combined ESG Score 298

Trends Driving ESG Materiality 299

Quantitative Approaches to ESG Analysis 300

Qualitative Analysis: Verifying and Supplementing Quantitative Analysis 301

ESG Regulations 302

Risk and Reward 303

Derivative and Alternative Instruments 304

Stranded Assets 305

Sustainable Investing 306

Chapter 18: Ten Factors Influencing the Growth of ESG Investing 307

Climate Change: The Route to Net Zero 308

Environmental and Social Issues Coming to the Fore 308

Stewardship as a Driver for Change 309

ESG Disclosures 310

Accounting 311

Regulation and International Standards 312

Impact Investing: Actively Do Good versus “Do No Harm” 313

Data and Technology 314

Consolidation of the ESG Ratings Companies 315

Political Impacts: Geopolitics and Public Pressure 316

Appendix: Great Resources For ESG Investing 319

Index 327