ESG Rating: What it means for companies and investors
We explain the most important points about ESG and why you should pay attention to an ESG rating for your investments.
More and more investors are considering ESG ratings when it comes to selecting their investments because ESG ratings provide deep insights into companies they want to invest in and highlight the standards these companies uphold regarding sustainability and ethical practices.
We’ll explain exactly what lies behind the term ESG and what impact it has on asset management as well as companies in this article.
ESG Definition
The term ESG may seem intimidating at first glance, but it’s not rocket science. The abbreviation stands for Environmental, Social, and Governance, covering areas that also play a significant role in everyday life: environment, social issues, and corporate governance.
The ESG rating serves to evaluate companies based on these three factors, providing transparency for investors so they are aware of where they are putting their money. It’s important to note that the relevance of these factors may be weighted differently depending on the industry, which is why an ESG rating should always be considered in the overall context.
E stands for Environmental
The aspect “Environmental” refers, as you may have already guessed, to the impact a company has on the environment.
- Greenhouse gas emissions
- Energy consumption
- Water usage
- Waste disposal and recycling
- General environmental protection measures
Environmentally friendly companies advocate for practices that minimize their ecological footprint and actively contribute to the preservation of resources.
S stands for Social
The exploitation of labor and customers is still a global problem even today. Unfortunately, this happens all too often in Switzerland as well, despite legal frameworks aimed at protecting employees and customers. Therefore, companies undergo scrutiny in the “Social” aspect during an ESG screening to assess their treatment of employees, customers, and suppliers.
This may include the following points:
- Employee rights and working conditions
- Health and safety of employees
- Diversity and inclusion in the workplace
- Customer satisfaction
G stands for Governance
The factor “Governance” refers to how a company is managed and governed.
These points are addressed:
- Transparency in corporate governance and structure
- Risk management
- Compensation
- Anti-corruption measures
- General business practices
In essence, the ethics and culture of companies are examined in this aspect during an ESG screening.
The origins of the ESG Criteria
A Swiss invented it!
In 2004, Ivo Knoepfel participated in the “Who Cares Wins” study on behalf of the United Nations. This document marked the first usage of the abbreviation ESG, gradually leading to the term’s widespread adoption. However, it’s challenging to pinpoint Ivo Knoepfel as the originator of the term ESG, and the exact moment of the concept’s emergence is unclear due to its decades-long development.
In general consensus, the ESG concept evolved from the foundational principles of Socially Responsible Investing (SRI) and Corporate Social Responsibility (CSR) in the 1960s and 1970s. During that time, the idea emerged that companies should not only aim to maximize profits but also take responsibility for social and environmental factors. The origins of SRI and CSR can actually be traced back several centuries.
With Ivo Knoepfel’s contribution, not only was the term ESG used for the first time, but the ESG criteria were also defined and documented for the first time.
Why are ESG criteria important for investing?
Sustainability – to put it briefly and succinctly. Essentially, sustainability means nothing other than “a long-lasting impact”. In this context, the term can take on several forms:
- Growth
- Risk reduction
- Reputation and brand value
Companies actively striving to adhere to ESG criteria typically have a lower risk of being involved in social, political, or environmental scandals. They choose practices that conserve their resources and ensure their longevity. As a result, companies are stable in the long term and can expand their growth upwards thanks to this stability and a positive reputation.
For investors, the long-term success of companies is crucial in choosing investments, as success manifests itself in the form of positive returns.
How to identify if investments meet ESG criteria?
Adhering to ESG criteria in investments is often symbolized by the indicator “ESG-screened“. However, it’s important to note that the label doesn’t always indicate a positive assessment but merely the scrutiny of a company by professional analysts, asset managers, and advisors.
As the term isn’t an official label like “Fair Trade” but an unprotected term, its usage can vary. Generally, though, the term “ESG-screened” informs investors that a company has the necessary data available to assess compliance or non-compliance with ESG criteria.
How are ESG ratings created at findependent?
For our ESG screening, we utilize analyses from MSCI, which encompass business activities, company size, and locations of operations. MSCI analyzes the ESG risks to which a company is exposed, how it manages these risks, and how it compares to other companies in the same industry. For this purpose, they receive a rating from “CCC” (Laggard) to “AAA” (Leader).
ESG Evaluation
A major issue associated with ESG is the lack of uniformity in ESG ratings. These ratings are subjective and can be influenced by various factors such as interests and perspectives. In other words, there are no standardized procedures for conducting an ESG screening. Therefore, two analysts may review the same company but arrive at different ESG ratings.
Another issue with ESG ratings is that large companies often receive better ratings simply because they can provide more data compared to small companies, regardless of whether this data actually demonstrates sustainability or not. Additionally, many companies pursue short-term ESG measures, leading to a rapid improvement in their ESG rating but cannot be sustained in the long term. For this reason, ESG ratings do not always reflect the actual sustainability standards of a company and may only be “corrected” once the company is already involved in a scandal.
Greenwashing
The term Greenwashing repeatedly emerges in various situations, including investing. This involves companies advertising with “green” terms and slogans that are not legally protected and therefore do not offer real weighting or protection against misuse.
Let’s take a simple example of buying yogurt: You’re faced with the choice between yogurt A and yogurt B, which have the same price and are nearly identical, making the decision quite challenging. Suddenly, you notice the label on yogurt A saying “made from 100% natural ingredients.” It becomes clear to you: yogurt A is coming home with you because, compared to otherwise identical yogurt B, it offers a benefit. After all, such big claims can’t be made if they aren’t true! Unfortunately, they can. Broad statements like those on yogurt A are not legally protected and can be legally used by companies for advertising purposes, even if they aren’t based on actual facts.
Similarly to yogurt A, companies can use a good ESG rating to enhance their reputation in the public eye and thus with investors. Environmental friendliness, in particular, is gaining more and more importance in our society, which is why many companies attempt to convince the public of their commitment to environmentally harmful practices. However, in reality, the cessation of these practices often has little to no positive impact on the environment. When a company decides to distance itself from its environmentally harmful activities, it often means that these activities are not discontinued but merely sold, thus continuing to exist and influence the environment.
ESG won’t save the world
To be completely transparent with you: No, exclusively investing in ESG-screened assets will not change the world overnight. Our environment will not be magically saved because we decide to only support ESG-compliant companies. Non-ESG compliant companies will continue to operate and be successful. While companies may feel increasing pressure to make their practices more environmentally friendly and ethical, as mentioned earlier, this does not necessarily mean a real reduction in controversial activities.
The decision to invest in ESG-screened companies is made for one’s own conscience. Knowing that your invested money is not flowing into immoral businesses and that the resulting returns can be received with a clear conscience does make for better sleep at night.
Investing in ESG-screened ETFs with findependent
Since we have chosen to avoid certain industries for ethical and sustainable reasons, we exclusively use ESG-screened ETFs for all equity investments outside of Switzerland in our five ready-made findependent investment solutions. As mentioned earlier, ESG-screened investments alone do not bring about enormous change in the world. However, it is important to us to morally support our investment solutions and the ETFs used, for both your and our conscience.
It is important to note that our ESG-screened ETFs are not more expensive than non-screened ETFs, as we continue to follow our principle: making investing accessible to everyone in Switzerland, even with small amounts.
Currently, we can only offer ESG-screened ETFs in our foreign investments, as there are not yet sufficiently established ESG data available for our Swiss ETFs. Once this changes, we will also integrate only ESG-screened ETFs into our investment solutions for our Swiss ETFs.