ESG--The THREE Components--Environmental, Social, and Governance

By: Lindsey Simek

When we think of ESG and implement ESG into our portfolios, there always seems to be a common theme.  Most people, when thinking of ESG investing, just consider the environmental element. We need to remember that ESG investing consists of three aspects, Environmental, Social, and Governance. However, many of us forget about the Social and Governance factors and focus merely on the Environmental component as that is the primary factor discussed in the news, etc.

For a company to be considered ESG it must meet a certain criterion. A company will receive an ESG score that transparently and objectively measures a company’s relative ESG performance as well as its commitment to ESG and its overall effectiveness. 

It is obvious what is taken into consideration when scoring the Environmental aspect. This would include corporate climate policies, energy use, waste, pollution, natural resource conservation, and treatment of animals. Also, considerations may include direct and indirect greenhouse emissions, management of toxic wastes, and compliance with environmental regulations (Environmental, Social and Governance (ESG) Scores from Refinitiv) . Again, all this is apparent and exactly what we think of when thinking about investing responsibly and ESG investing and asking “how is a particular company reducing their carbon footprint?” 

 However, when scoring the Social and Governance factors, the considerations are not quite as evident, yet they play a major role in a company’s ESG effectiveness.  As for the Social factor, the score is based on community, human rights, product responsibility, and workforce. It needs to be considered whether the company holds its suppliers to its own ESG standards. How does it support its community, does the company donate to local charities and encourage employees to volunteer their time? The workplace conditions need to be assessed and it needs to prove that there is a high regard for employees’ health and safety. Another important issue that is considered is a company’s support for LGBTQ rights and their encouragement of diversity. Finally, are employees paid fair wages and in the event of sexual misconduct, what are the company policies and procedures and what is done to protect employees. 

The Governance portion includes management, shareholders, and CSR strategy. ESG governance standards push for companies use precise and transparent accounting techniques, diversify in selecting its board and leadership, and finally is accountable to its shareholders while embracing corporate transparency (Environmental, Social and Governance (ESG) Scores from Refinitiv). 

While the environment is a major factor, it is important to remember that it is not the only factor when it comes to ESG investing. All three components (Environmental, Social, and Governance) play major roles in a company’s ESG effectiveness, combining all the factors. Also, picking out what is important to you as investor is what we listen to.  Some that are concerned with the environment first and foremost, we can focus on the E, while women’s rights, the S and G are the main drivers for example. 

Also, investing within ESG factors, doesn’t mean worse returns.  For one year and Year to Date as of August 16, 2022, our portfolios that don’t have ESG factors vs our ESG portfolios are less than 1% difference. Some portfolios such as our Max Balanced 55 which is a moderate portfolio, the ESG model outperformed YTD by .6% and slightly underperformed 1 year by .2% showing that having an ESG focus can still have the same long term financial goals.

If you want to look at how we could implement the E, the S, the G, or all three components, into your portfolio, please call or email anytime.

Thank you again for your trust in Capstone Investment Financial Group.

Past performance is not indicative of future results. 

ESG implementation is done on a best efforts basis and there can be no guarantee that the portfolio will not include investments not ideally suited to meet the requested exclusions of the client.

Sources Cited

Environmental, Social and Governance (ESG) Scores from Refinitiv

Returns from portfolio data in FoloFn and available upon request