ESG – Ethical Investing Or Recipe For Disaster?
- Apr 26, 2022
- 4 min read
Written by: Ryan Daniels, Executive Contributor
Executive Contributors at Brainz Magazine are handpicked and invited to contribute because of their knowledge and valuable insight within their area of expertise.
A-B-C-D. ESG? Probably not how you learned your ABCs in pre-school. You might not have heard of the ESG movement, but you need to be aware as it has the potential to completely transform how you invest and business operations as we know it.
Environmental, Social, and Governance (ESG) is a means by which companies are evaluated to determine their non-financial impact. ESG investing is also referred to as ‘sustainable investing’ or ‘socially responsible investing. Critics sometimes refer to it as a ‘social credit scoring system.’
ESG Factors
Environmental accesses the impact a business has on the environment. Uses metrics such as:
Carbon footprint
Climate change mitigation
Waste management
Social focuses on a business’s diversity and inclusion measures as well as a stance on social issues. Key metrics are:
Diversity of the workforce and board of directors
Racial Justice
Equity in areas such as pay and promotions
Governance evaluates how a business operates in terms of its structure and philosophy. Key factors of governance include:
Sustainability oversight
Executive compensation
Political contributions
Potential Impact
The ESG movement has the potential to not only impact businesses but everyday citizens as well. Capitalism is set up where you as the investor can buy ownership into companies via your investments and become a shareholder. The company then has a responsibility to grow profits for its shareholders. Shareholders, therefore, are the ones who determine what non-financial impacts are important, not a select group issuing ESG ratings. The easiest way for a company to decide if non-financial impacts were important to shareholders is they would divest if a company pursued policy shareholders disagree with. Contrary, if a company pursued a policy that was attractive to shareholders, a business would see an increase in stock purchases. This is important because competition is what drives not only the profitability of companies but drives innovation by which everyone benefits.
The Great Shift
A shift is underway to have companies focus on serving stakeholders instead of shareholders. This is outlined clearly by political activists all throughout the world looking to fundamentally change the global economy. It might sound insignificant, but stakeholders can be as broad as the general public where shareholders will have a financial interest in the company. This is important because if companies are not beholden to shareholders, then priorities such as those of ESG can shift time and resources away from activities focused on profitability. You might be wondering well why that is such a bad thing? Don’t companies have enough money already?
Why it’s important!
Shifting to a stakeholder focus rather than a shareholder focus will impact the profitability of companies. If focus is shifted away from profits, then costs of doing business most certainly rise and will be passed along to consumers because companies must make a profit or they will go out of business. Competition and innovation have always made companies find ways to produce products for less money. To stay profitable, they must continually look for ways to improve efficiency and meet the needs of consumers. If attention shifts to non-financial factors such as those of ESG, the motivation to innovate and keep costs down is no longer the priority and consumers will see the results hit their wallets.
Advocates vs. Opponents
ESG proponents argue businesses have further responsibility beyond profits to operate in accordance with the ESG principles outlined above. However, critics argue an ESG score can and will be used to discriminate against businesses that don’t align with the agenda of those who issue the scores. Companies with low ESG scores could be penalized with higher loan rates or less access to banking systems, which could hinder their growth and ability to innovate through new projects.
ESG is real and is being embraced by many large asset managers, most prominently BlackRock and Vanguard. The Securities Exchange Commission (SEC) has even developed an enforcement task force https://www.sec.gov/news/press-release/2021-42.
Investors Beware!
Bank of America has even gone as far as to issue ESG scores for individual investors. Many analysts believe individual ESG scores will be used in the future by banks and other institutions in part to determine your credit risk and possibly loan rates or ability to utilize the banking system.
It’s important to be aware of the ESG movement, but I will leave you to decide on the merits and whether the markets will adapt or be destroyed by the concept. For everyday investors, never forget the importance of having a strong financial plan that fits your life and following the basics principles of investing. To learn more about the basics of money and how to build a strong financial plan, check out “Money Basics & Fundamentals (Build a Plan That Fits Your Life!)” available on Amazon.
Ryan Daniels, Executive Contributor Brainz Magazine
Ryan Daniels is a licensed financial advisor and owner of RFinances. As a U.S. Army Veteran, Ryan and his team continue to serve by partnering with businesses, churches, and community groups to host workshops to teach people the basics of money. They also provide 1 on 1 financial coaching to help people build a simple-to-follow financial plan that fits their life. Ryan is the author of "Money Basics and Fundamentals (Build A Plan That Fits Your Life!)" and host of the "Say Hi to Money" podcast.
