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You must have noticed certain subtle changes around you in the last few years – Paper straws over plastic straws, an increase in the number of vegan cafes and restaurants in the city, and more and more companies having an LGBTQ+ ad campaign during pride month in June. This is because the world today demands businesses and individuals alike to be more cognizant and responsible towards the society and environment they function in. And that’s where the concept of ESG investing comes in.

Environmental, Social, and Governance (ESG) investing means investing in companies that focus on creating a positive impact socially and environmentally while earning profits and growing. Also known as social investing or impact investing, ESG investing is typically based on scores or ratings provided to companies by independent, third-party agencies. These scores help investors assess how a specific company’s policies, business model, and behaviour fair with regard to environmental footprint, social impact, and governance issues. Let’s understand these criteria better.

Criteria for evaluating companies for ESG investing:

1. Environmental: What is the company’s carbon footprint? How efficient is the company’s supply chain? Are toxic chemicals and materials involved in its manufacturing processes? Such environmental concerns impact the ESG ratings of companies. For instance, the fashion industry is the world’s second-largest industrial polluter and accounts for 8-10% of global carbon emissions and almost 20% of wastewater. Over the last few years, clothing giants have been criticised for fast fashion which has led them to begin focusing more on sustainable fashion.

2. Social: What are the company’s hiring practices? Does it practise inclusivity in the workplace as well as in its product advertising and messaging? Does the company advocate for social good, including LGBTQ+ rights, racial diversity, etc.? It includes various factors that determine how a company interacts with its employees, customers, and society at large.

3. Governance: How is a company led and managed? How transparent are internal policies? Is the leadership accountable? How are shareholder rights viewed? The governance factor in ESG includes everything related to management structures, company policies, information disclosures, and compliance issues.

But do adding ESG investments benefit your portfolio as an investor? Let’s find out:

ESG investments’ performance: What you need to know?

• Returns: Some investors may believe that ESG investments are only for a social cause and not to earn good returns, but that’s not true. In fact, most ESG funds have outperformed their peers. According to Morningstar, over a 10-year period through 2019, about 58.8% of sustainable funds have delivered higher returns than their peers.

• Volatility: ESG investments tend to hold up well during periods of market volatility. A study by MSCI shows that during the COVID-19 sell-off in the first half of 2020, four standard global ESG indexes outperformed their benchmark index.

• Risk: There are a host of internal and external business environment risks that a company faces and hence the stocks you invest in also face. These risks include supply-chain risks, management risks, compliance risks, and more. However, when it comes to companies with a high ESG score, these risks are reduced as they tend to practise stronger business ethics and have more transparent policies in place that can hold up better in times of crises and uncertainty.

Should you invest in ESG?

Yes, when you want to build wealth over the long term, ESG investing is a strategy that can work for you. The companies of the future are expected to be the ones that put equal emphasis on people, world, and profit.

Larry Fink, CEO of one of the biggest investment management companies, BlackRock, said, “The next 1,000 unicorns won’t be search engines or social media companies. They’ll be sustainable, scalable innovators – startups that help the world decarbonise and make the energy transition affordable for all consumers.”

You can add ESG investments to your portfolio through stocks of companies with a high ESG score, such as Microsoft, Salesforce, Nvidia, Nike, and Mattel or through ESG funds like Vanguard FTSE Social Index Fund (VFTAX), iShares MSCI USA ESG Select ETF (SUSA), and Shelton Green Alpha Fund (NEXTX).

Author is CEO, Appreciate, a fintech platform for savings and investments. Views are personal.