ESG investing incorporates elements of sustainable, socially responsible, and impact investing and is a method for evaluating how a company’s environmental, social, and governance practices may impact its stock return potential.

Below is a closer look at the three criteria for ESG:

• Environmental considerations include carbon emissions, waste, natural resource efficiency, renewable energy usage, and climate change initiatives.
• Social factors can be elements such as workplace diversity, human capital and supply chain management, product integrity and safety, and community impact.
• Governance generally incorporates board and executive diversity, corporate structure, accounting practices, transparency, and executive compensation.

There are various ESG rating systems set up by different ratings agencies; some of the rating systems are ESG performance-based while others are ESG risk-based.

The major ESG rating agencies include MSCI, RobecoSAM, CDP Global Environmental Information Research Center, and FTSE Russell, among others.

These companies provide ratings based on their ESG policies and systems and measures, and they gather information from multiple sources including companies’ publications, the government data bank, media, nongovernmental organizations (NGOs), and other stakeholders. Questionnaires may also be used to collect additional information from the companies.

During the rating process, the agencies will use a specific mechanism to adjust the score of the company based on its industry. At the same time, the relative performance of the company against its peers will also be used as a benchmark to obtain a universal rating that’s comparable across industries.

A Note on ESG Scores

Some ESG investments use negative screens that exclude or underweight companies that don’t score well, while others use positive screens to weight high-scoring companies more heavily.

Still others will completely exclude certain parts of the market—such as weapons, tobacco, or companies who rank poorly on carbon emissions.

Investors should do their research if there are specific products or practices they want to avoid. However, it’s important to remember there’s no such thing as a perfect company.

For that reason, many institutional ESG investors also use their power as shareholders to engage in direct dialogue, proxy voting, and shareholder proposals. Shareholder practices can encourage companies to follow ESG guidelines and continuously improve in these areas.

There are several terms often used interchangeably when referring to investing with a cause in mind.

However, each strategy typically has different goals and methods. Here’s a look at the different investing practices and how ESG incorporates elements of each.

What Is Sustainable Investing?

Sustainable investing typically focuses on an investment’s impacts on the environment. In a portfolio, it involves underweighting or excluding companies with poor environmental considerations or overweighting companies with positive environmental practices.

For example, a sustainable mutual fund manager may select companies that use environment-friendly product designs or exclude companies that emit harmful toxins and pollutants as part of their manufacturing processes.