Understanding ESG Investing: 9 Terms To Know

By the Inspired Investor TeamMarch 22, 2022

Deepen your understanding of responsible investing with these concepts.

This article was originally published in RBC Direct Investing’s Inspired Investor magazine.

The numbers are in: more and more people want their investing dollars to make a difference in the world. But whether you’re among the 79 per cent of Canadians already considering investing in companies that are committed to environmental, social and governance (ESG) values, or simply want to know more about investing responsibly, the underlying concepts can be a good place to start. Here, we take a closer look at nine key terms related to ESG investing and what they mean.

ESG: This acronym stands for environmental, social and governance — three factors that investors can use to help in evaluating risks and opportunities associated with those factors. Considering these factors as part of an investment approach is called ESG integration.

Environmental criteria considers how a company acts as an environmental steward, while social criteria may look at how a company treats its employees, customers and communities. Governance examines how a company governs itself, from executive pay to issues like board gender diversity and board independence.

Responsible Investing (RI): Sometimes referred to as “ESG investing” or “sustainable investment,” responsible investing is an umbrella term for a broad range of investing approaches that incorporate ESG considerations. Responsible investing includes three investment strategies: ESG integration, socially responsible investing (SRI) and impact investing.

Socially Responsible Investing (SRI): This is the practice of investing in companies and funds that have a positive impact on society, often through the application of screens based on a defined set of values. Negative screening excludes companies with a negative impact on society — think tobacco companies or known polluters — while positive screening actively seeks out companies with practices, products or services that have the potential to make the world a better place.

Impact investing: A subset of ESG investing, impact investing prioritizes measurable positive social or environmental change generated by companies, organizations or funds. A financial return is still a goal for impact investors, but not the only priority.

Greenwashing: Making false or misleading claims about a company or product to make it seem more environmentally friendly than it really is. Greenwashing is a growing area of concern as ESG becomes more popular.

It can be difficult to recognize greenwashing, but investors may be wise to do some due diligence. For example, one could read the prospectus instead of just the marketing brochure, and research a company’s plan to reach its sustainability targets rather than accepting its goals at face value.

Conscious capitalism: A philosophy put forward by marketing professor Raj Sisodia and Whole Foods co-founder John Mackey, conscious capitalism is the idea that corporations should act ethically as they pursue profits, serving the interests of all stakeholders, not just management and shareholders.

Four key tenets help guide the movement:

1.Higher purpose: businesses should exist for reasons beyond making a profit.

2.Stakeholder orientation: the needs of all stakeholders — from employees and customers to suppliers and investors — should be balanced equally.

3.Conscious leadership: leaders should embrace the higher purpose of the company and be driven by service to it.

4.Conscious culture: leaders should intentionally create a corporate culture that promotes their values and purpose.

ESG score: One way to identify companies with strong ESG practices is to determine if they have an ESG score. Several organizations assign ESG ratings, mostly online. A current market leader is MSCI ESG, whose ratings rank potential investments on a letter scale from AAA (leaders) to CCC (laggards). It’s important to note that metrics for assessing companies aren’t yet standardized and organizations may weigh ESG factors differently.

In November 2021, following industry-wide consultation, the CFA Institute released the first-ever voluntary global ESG disclosure standards for investment products that it hopes will be soon widely adopted by fund companies around the world.

ESG disclosure standards: Disclosure refers to the timely release of all information about a company that may sway an investor’s decision. ESG disclosure standards would provide investors with full acknowledgement of ESG issues in a company’s objectives, investment processes and stewardship activities.

Divestment: Divestment refers to selling or avoiding investments in companies, sectors or countries based on specific activities. For example, investors looking to address climate change might choose to divest from sectors with a large carbon footprint.

This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.