Environmental, social and governance factors are collectively referred to by the acronym “ESG”. ESG integration is the practice of considering environmental, social, and governance factors in the investment process, and can be implemented across all asset classes, including equities, fixed income, and alternative investments.
Sustainable investing (SI) and responsible investing (RI) are sometimes used interchangeably with ESG integration. Socially Responsible Investing (SRI) is an investment strategy that is said to incorporate ESG issues, but which has been historically represented by the practice of excluding companies and industries from investment consideration on the grounds that they oppose an investor’s moral or ethical values.
Managers and investors tend to define and implement ESG mandates in many different ways. As a result, there are often differences among investors regarding which ESG factors should be considered in the investment process and to what extent they should be implemented within a portfolio.
ESG Factors considered in the Investment Analysis Process
Pollution prevention, energy efficiency, reduced emissions, and adherence to environmental safety and regulatory standards are some of the key environmental factors which are considered in the investment analysis process.
With respect to the influence of social factors on the investment analysis process, consideration is usually given to human rights issues and welfare concerns in the workplace as well as the impact of product development on the community.
ESG integration can be implemented through several methods, namely negative screening, positive screening, best-in-class, thematic investing, and impact investing.
Negative screening or exclusionary screening describes the practice of excluding certain sectors or companies from investment consideration due to the nature of their underlying business activities or other environmental or social concerns.
Positive screening and best-in-class strategies select investments which have favorable ESG characteristics. Positive screening focuses on companies which embrace positive ESG-related principles such as companies with policies promoting pollution prevention. The best-in-class approach seeks to identify companies which record the highest ESG score in their industry.
Thematic investing emphasizes a single factor, such as energy efficiency or climate change.
Impact investing seeks to achieve targeted social or environmental objectives along with measurable financial returns through engagement with a company or by directly investing in projects or companies. It can be executed through various asset classes and investment vehicles, often through direct transactions, such as venture capital investing.
Which of the following is least likely an ESG implementation method?
B. Positive screening
C. Impact investing
The correct answer is A.
Worst-in-class is not the name of an ESG implementation strategy. On the flip side, best-in-class describes an ESG approach which seeks to identify the best ESG-scoring companies in each industry. B and C are incorrect because positive screening and impact screening are both examples of ESG implementation methods.
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Describe how environmental, social, and governance factors may be used in investment analysis