Environmental, Social, and Governance (ESG)
Many investors who want ethical portfolios generally have three broad criteria in mind: they want the companies they invest in to be responsible environmental stewards, behave responsibly towards both employees and the communities in which they operate, and be committed to quality executive leadership. These three factors have been called Environmental, Social and Governance Criteria, or ESG.
The environmental requirement for an ESG designation are easiest to identify. With the ongoing threat of climate change and resource depletion, an ESG analysis looks at whether a company is operating in an environmentally sustainable manner. The environmental analysis looks for non-sustainable business activities like excessive depletion of natural resources (especially non-renewable ones), operation in environmentally sensitive landscapes or areas inhabited by endangered species, and over-consumption or pollution of freshwater.
The social requirement for an ESG designation is more abstract, and requires extensive analysis of a business' entire supply chain. The goal is to identify companies that behave responsibly towards their employees and communities at each point in the supply chain. Factors that social analysis looks for include human rights abuses, a lack of diversity in hiring practices, poor safety standards for either employees and outsourced work, predatory practices against consumers, and fair wages for labor.
The governance requirement for an ESG designation looks at the way a company is run. This factor examines companies for a management structure which avoids conflicts of interest, diversity in leadership roles, proactive corporate risk management policies, responsiveness to stockholder rights, and policies preventing excessive executive compensation.
Since the interpretation and implementation of ESG criteria will be unique to each firm, it is a good idea to ask your financial advisor what criteria they use to develop their ESG portfolios.