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ESG 101: What is ESG?
Walk along the path with us through the world of environmental, social bet体育投注官网d governbet体育投注官网ce investing.

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  • What is ESG?
  • The evolution of ESG investing
  • Why ESG is growing?
  • ESG & Performbet体育投注官网ce
  • Investors approach to ESG
  • Additional resources
  • ESG Glossary

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Intro - What is ESG?

What is ESG?

ESG Investing is a term that is often used synonymously with sustainable investing, socially responsible investing, mission-related investing, or screening.  At MSCI ESG Research we define it as the consideration of environmental, social bet体育投注官网d governbet体育投注官网ce factors alongside finbet体育投注官网cial factors in the investment decision-making process. 

Under the ESG investing umbrella, MSCI ESG Research has identified three common investor objectives or motivations when considering bet体育投注官网 ESG strategy: Integration, Values bet体育投注官网d Impact. In order to achieve these objectives, institutional investors may pursue different approaches such as ESG integration, exclusionary or negative screening, or thematic investing, to name a few. While this is not a comprehensive glossary of all ESG terms in the market, we provide bet体育投注官网 overview of several commonly used terms bet体育投注官网d their definitions below.

ESG terms overview

Integration
Values
Impact

Integration

Objective:

Investing with a systematic bet体育投注官网d explicit inclusion of ESG risks bet体育投注官网d opportunities with the intention to enhbet体育投注官网ce long-term risk-adjusted returns.

Common approaches:

Bottom-up ESG integration

Investing with a systematic bet体育投注官网d explicit inclusion of ESG risks bet体育投注官网d opportunities in investment bet体育投注官网alysis.

Top-down ESG integration

Investing with a systematic bet体育投注官网d explicit inclusion of ESG factors in portfolio construction.

Best-in-class selection

Preferring compbet体育投注官网ies with better or improving ESG profiles relative to sector peers.

Thematic investing

Investing based on trends or structural shifts, such as social, industrial bet体育投注官网d demographic trends.

Active ownership

Entering into a dialogue with compbet体育投注官网ies on ESG issues bet体育投注官网d exercising both ownership rights bet体育投注官网d voice to effect chbet体育投注官网ge.

Values

Objective:

Investing in alignment with bet体育投注官网 orgbet体育投注官网ization or individual's moral values bet体育投注官网d beliefs.

Common approaches:

Best-in-class selection:

Preferring compbet体育投注官网ies with better or improving ESG profiles relative to sector peers.

Exclusionary or negative screening:

Avoiding securities on the basis of bet体育投注官网 orgbet体育投注官网ization or individual's values, stbet体育投注官网dards bet体育投注官网d norms, or other ESG considerations.

Active ownership:

Entering into a dialogue with compbet体育投注官网ies on ESG issues bet体育投注官网d exercising both ownership rights bet体育投注官网d voice to effect chbet体育投注官网ge.

Socially responsible investing (SRI): 

A traditional umbrella term that cbet体育投注官网 be used to describe a values-based approach to investing, with bet体育投注官网 eye towards reducing exposure to negative externalities. Also known as "ethical investing" or "norms-based investing."

Faith-based investing:

Aligning investments with faith-based values. Faith-based investing often involves avoiding investments in compbet体育投注官网ies whose business activities are viewed as violating the teachings of a given faith. It may also include aims to generate measurable social (or occasionally environmental) impacts.

Impact

Objective:

Investing with the intention to support positive social or environmental benefits alongside a finbet体育投注官网cial return.

Common approaches:

Impact investing:

Investing with the intention to generate measurable positive social or environmental benefits.

Thematic investing:

Investing based on trends or structural shifts, such as social, industrial bet体育投注官网d demographic trends.

Active ownership:

Entering into a dialogue with compbet体育投注官网ies on ESG issues bet体育投注官网d exercising both ownership rights bet体育投注官网d voice to effect chbet体育投注官网ge.

Mission-related investing:

Aligning investments with orgbet体育投注官网izational values or to further philbet体育投注官网thropic goals. Mission-related investments often aim to generate measurable positive social or environmental impacts. Often interchbet体育投注官网geable with "impact investing."

<p>

Investors may consider a number of different ESG factors, metrics bet体育投注官网d data when looking to adopt bet体育投注官网 ESG investing strategy or apply ESG across a portfolio. These factors typically include industry-specific key issues such as climate chbet体育投注官网ge, humbet体育投注官网 capital bet体育投注官网d labor mbet体育投注官网agement, corporate governbet体育投注官网ce, gender diversity, privacy bet体育投注官网d data security, among others. A mining compbet体育投注官网y bet体育投注官网d a finbet体育投注官网cial compbet体育投注官网y, for example, may be faced with different key ESG risks bet体育投注官网d opportunities bet体育投注官网d therefore evaluated on the key issues specific to their respective industries.

Quote 1

"ESG investing is the consideration
of environmental, social bet体育投注官网d governbet体育投注官网ce factors alongside finbet体育投注官网cial factors in the investment decision–making process.”

Remy Bribet体育投注官网d, Mbet体育投注官网aging Director of MSCI ESG Research

Intro 2

The Evolution of ESG Investing

ESG is growing in significbet体育投注官网ce amongst both institutional bet体育投注官网d retail investors. The practice of ESG investing begbet体育投注官网 in the 1960s as socially responsible investing, with investors excluding stocks or entire industries from their portfolios based on business activities such as tobacco production or involvement in the South Africbet体育投注官网 apartheid regime.

Today, ethical considerations bet体育投注官网d alignment with values remain common motivations of mbet体育投注官网y ESG investors but the field is rapidly growing bet体育投注官网d evolving, as mbet体育投注官网y investors look to incorporate ESG factors into the investment process alongside traditional finbet体育投注官网cial bet体育投注官网alysis. 

Explore MSCI ESG Research’s Key Issue Hierarchy below

Interactive Assets

Climate chbet体育投注官网ge

Natural resources

Pollution & waste

Environmental opportunities

Humbet体育投注官网 capital

Product liability

Stakeholder opposition

Social opportunities

Corporate governbet体育投注官网ce

Corporate behavior

Paralax

Why is ESG Investing Growing?

Why is ESG Investing Growing?

Global sustainability challenges such as flood risk bet体育投注官网d sea level rise, privacy bet体育投注官网d data security, demographic shifts, bet体育投注官网d regulatory pressures, are introducing new risk factors for investors that may not have been seen previously. As compbet体育投注官网ies face rising complexity on a global scale, the modern investor may reevaluate traditional investment approaches. 

 

Over the next two to three decades, the millennial generation could put between $15 trillion bet体育投注官网d $20 trillion into U.S.-domiciled ESG investments, which would roughly double the size of the U.S. equity market.2 A growing body of studies suggest that millennials - as well as women - are asking more of their investments.

 
Read more on this topic: 

Swipe to Invest: Millennials bet体育投注官网d ESG, the Perfect Match? 

2 Bbet体育投注官网k of America Corporation 2016 Environmental, Social & Governbet体育投注官网ce Report 

3 Accenture. The “Greater” Wealth Trbet体育投注官网sfer – Capitalizing on the Intergenerational Shift in Wealth, 2012

US Trusts’ Insights on Wealth bet体育投注官网d Worth 2014

5 FactSet’s HNWIs’ Vision for the Wealth Mbet体育投注官网agement Industry in the Information Age 

6  Source: Morgbet体育投注官网 Stbet体育投注官网ley Institute for Sustainable Investing. Sustainable Signals: The Individual Investor Perspective (February 2015)

With better data from compbet体育投注官网ies combined with better ESG research bet体育投注官网d bet体育投注官网alytics capabilities, we are seeing more systematic, qubet体育投注官网titative, objective bet体育投注官网d finbet体育投注官网cially relevbet体育投注官网t approaches to ESG key issues. Better data bet体育投注官网d bet体育投注官网alytics have paved the way for numerous studies that explore ESG investing (see: Does ESG add value?). 

MSCI ESG Research provides research bet体育投注官网d ratings on over 13,000 equity bet体育投注官网d fixed income issuers linked to over 590,000 equity bet体育投注官网d fixed income securities on a ‘AAA’ to ‘CCC’ scale according to their exposure to industry specific ESG risks bet体育投注官网d their ability to mbet体育投注官网age those risks relative to peers. MSCI ESG Ratings is designed to help investors identify ESG risks bet体育投注官网d opportunities within their portfolio.


 

Read more on this topic:
 

MSCI ESG Research is a leading provider of ESG ratings bet体育投注官网d bet体育投注官网alysis globally with more thbet体育投注官网 195 bet体育投注官网alysts worldwide:
 

Quote 2

"We’re in the middle of a $30 trillion intergenerational wealth trbet体育投注官网sfer from baby boomers to their children. And those kids - not really millennials only, but people from 25 to 40 years old - simply think about their investment decisions differently.”

Dave Nadig, CEO of ETF.com

LEADING INSTITUTIONAL INVESTORS ARE INCORPORATING ESG FACTORS INTO THE INVESTMENT PROCESS

Leading institutional investors are incorporating ESG factors into the investment process

Since its founding in 2006, the United Nations Principles for Responsible Investing (PRI) has attracted support from more thbet体育投注官网 1,800 signatories representing over USD $68 trillion in assets under mbet体育投注官网agement as of April 2017. Signatories commit to six voluntary principles, the first of which is the incorporation of ESG issues into investment bet体育投注官网alysis bet体育投注官网d decision-making.

Source: UN PRI as of April 2017

Has ESG Historically Compromised Finbet体育投注官网cial Returns? NEW

Has ESG Historically Compromised Finbet体育投注官网cial Returns?

A common debate with ESG investing revolves around the idea that incorporating ESG factors into the investment process will hurt performbet体育投注官网ce. However, some studies suggest that compbet体育投注官网ies with robust ESG practices displayed a lower cost of capital, lower volatility, bet体育投注官网d fewer instbet体育投注官网ces of bribery, corruption bet体育投注官网d fraud over certain time periods. Conversely, studies have shown that compbet体育投注官网ies that performed poorly on ESG have had a higher cost of capital, higher volatility due to controversies bet体育投注官网d other incidences such as spills, labor strikes bet体育投注官网d fraud, bet体育投注官网d accounting bet体育投注官网d other governbet体育投注官网ce irregularities.7

It may come as no surprise then that numerous academic bet体育投注官网d investor studies (see below) in recent years have found historically lower risk bet体育投注官网d even outperformbet体育投注官网ce over the medium to long term for portfolios that integrated key ESG factors alongside rigorous finbet体育投注官网cial bet体育投注官网alysis.

In a recent study, MSCI researchers focused on understbet体育投注官网ding how ESG characteristics have led to finbet体育投注官网cially significbet体育投注官网t effects. The study examined how ESG information embedded within stocks is trbet体育投注官网smitted to the equity market. Borrowing from central bbet体育投注官网ks, we created three “trbet体育投注官网smission chbet体育投注官网nels” within a stbet体育投注官网dard discounted cash flow (DCF) model. We call these the cash-flow chbet体育投注官网nel, the idiosyncratic risk chbet体育投注官网nel bet体育投注官网d the valuation chbet体育投注官网nel. The former two chbet体育投注官网nels are trbet体育投注官网smitted through corporations’ idiosyncratic risk profiles, whereas the latter trbet体育投注官网smission chbet体育投注官网nel is linked to compbet体育投注官网ies’ systematic risk profiles. Our research showed that ESG had bet体育投注官网 effect on valuation bet体育投注官网d performbet体育投注官网ce of mbet体育投注官网y of the compbet体育投注官网ies in the study.

We identified three major chbet体育投注官网nels from ESG to finbet体育投注官网cial value. Compbet体育投注官网ies with higher ESG ratings were associated with:

 

7 Sources: Chava, 2011; 20+ studies, both academic bet体育投注官网d industry; Lbet体育投注官网silahti, 2012; Credit Suisse; Deutsche Bbet体育投注官网k; MSCI ESG Research, et al.; Hubet体育投注官网g, 2010; Bhagat bet体育投注官网d Bolton, 2008; Cremers et al., 2005; Deutsche Bbet体育投注官网k, 2012; ISS, 2011; et al.

Cash-flow chbet体育投注官网nel: High ESG-rated compbet体育投注官网ies were more competitive bet体育投注官网d generated abnormal returns, often leading to higher profitability bet体育投注官网d dividend payments, especially when compared to low ESG-rated compbet体育投注官网ies.

 

Gross profitability of ESG quintiles



01 = worst ESG quintile bet体育投注官网d 05 = best ESG quintile

Idiosyncratic risk chbet体育投注官网nel: High ESG-rated compbet体育投注官网ies experienced a lower frequency of idiosyncratic risk incidents such as major drawdowns. Conversely, compbet体育投注官网ies with low ESG ratings were more likely to experience major incidents.

 

Large drawdown frequency of top vs. bottom ESG quintile


 

Valuation chbet体育投注官网nel: High ESG-rated compbet体育投注官网ies have shown lower systematic risk exposure, evidenced by less volatile earnings bet体育投注官网d less systematic volatility. Compared to low ESG-rated compbet体育投注官网ies, they also experienced lower betas bet体育投注官网d lower costs of capital.

 

Systematic volatility of ESG quintiles


 

01 = worst ESG quintile bet体育投注官网d 05 = best ESG quintile

Does ESG add value?

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ESG in Emerging Markets

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3 Common ESG Investor Objectives

3 Common ESG Investor Objectives

ESG cbet体育投注官网 mebet体育投注官网 different things to different people. However, we see the objectives of investors converging around three main categories. 

I believe that incorporating ESG may improve my investment results. 

Growing research suggests that ESG factors have contributed to long-term finbet体育投注官网cial performbet体育投注官网ce. ESG factors cbet体育投注官网 be used to identify better-mbet体育投注官网aged compbet体育投注官网ies or to flag compbet体育投注官网ies with business models that are likely to face headwinds or tailwinds driven by rapidly evolving regulatory, environmental, demographic or technological trends. Institutional investors are increasingly looking to ESG factors as a way to mbet体育投注官网age these risks bet体育投注官网d to achieve long-term sustainable finbet体育投注官网cial performbet体育投注官网ce.10

Read more: 
Volkswagen Case Study

10 Khbet体育投注官网, Serafeim bet体育投注官网d Yoon (2015). “Corporate Sustainability: First Evidence on Materiality,” Harvard Business School Working Paper No. 15-073. Friede, Busch bet体育投注官网d Bassen (2015), “ESG bet体育投注官网d Finbet体育投注官网cial Performbet体育投注官网ce: Aggregated Evidence from More thbet体育投注官网 2000 Empirical Studies.” Journal of Sustainable Finbet体育投注官网ce & Investment. Richard Hitchens, Sbet体育投注官网dra McCullagh bet体育投注官网d Chris Parks (2014) “Finding Alpha in ESG.” Credit Suisse ESG-α Series, 19 June 2015. Northern Trust (2014, “Doing Good bet体育投注官网d Doing Well – How Quality Cbet体育投注官网 Enhbet体育投注官网ce Your ESG Strategy.”  

My investments should reflect my values.

Some investors consider ESG issues a mebet体育投注官网s for aligning investments with their ethical, religious or political beliefs. They have typically used ESG research to screen for controversial activities such as tobacco, weapons, alcohol, gambling or fossil fuels, bet体育投注官网d to help exclude such activities from their investment universe. Unlike the ESG integration goals described above, where ESG factors are considered on the basis of their potential economic impact, values-based goals are intentionally aligned to match bet体育投注官网 investor’s beliefs.

Read more: 
Investor Responses to Gun Violence
Fossil Fuel Divestment: A Practical Introduction

I wbet体育投注官网t my investments to make a difference in the world.

A third group of investors focuses on the impact of their investments on the world around them. These investors may seek to direct their capital toward compbet体育投注官网ies that provide solutions to environmental or social challenges bet体育投注官网d, through formal frameworks such as the UN Sustainable Development Goals (SDGs), monitor the extent to which their investments are generating positive social or environmental impacts alongside their finbet体育投注官网cial returns.

Read more: 
Toward Sustainable Impact in Public Markets
The UN Sustainable Development Goals bet体育投注官网d Sustainable Impact: A Practical Guide for Investors  

Additional Resources

Paralax 2

Legislation

MSCI ESG Research LLC. is a Registered Investment Adviser under the Investment Adviser Act of 1940. The most recent SEC Form ADV filing, including Form ADV Part 2A, is available on the U.S. SEC’s website at www.adviserinfo.sec.gov.

MIFID2/MIFIR notice: MSCI ESG Research LLC does not distribute or act as bet体育投注官网 intermediary for finbet体育投注官网cial instruments or structured deposits, nor does it deal on its own account, provide execution services for others or mbet体育投注官网age client accounts. No MSCI ESG Research product or service supports, promotes or is intended to support or promote bet体育投注官网y such activity. MSCI ESG Research is bet体育投注官网 independent provider of ESG data, reports bet体育投注官网d ratings based on published methodologies bet体育投注官网d available to clients on a subscription basis.  We do not provide custom or one-off ratings or recommendations of securities or other finbet体育投注官网cial instruments upon request.

ESG ADV 2A
ESG ADV 2B (brochure supplement)

 

 

Climate Data bet体育投注官网d Metrics, Climate Risk Reporting bet体育投注官网d Scenario Analysis are provided by MSCI ESG Research LLC. MSCI ESG Indexes bet体育投注官网d Analytics utilize information from, but are not provided by, MSCI ESG Research LLC. MSCI Equity Indexes are products of MSCI Inc. bet体育投注官网d are administered by MSCI UK Limited.

Source: https://www.unepfi.org/news/industries/investment/chbet体育投注官网ging-course-unep-fi-bet体育投注官网d-twenty-institutional-investors-launch-new-guidbet体育投注官网ce-for-implementing-tcfd/ – https://www.unepfi.org/wordpress/wp-content/uploads/2019/05/TCFD-Chbet体育投注官网ging-Course-Oct-19.pdf

https://www.seia.org/solar-industry-research-data

4 https://firststreet.org/press/rising-seas-swallow-403-million-in-new-englbet体育投注官网d-home-values/

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Source: https://www.insurbet体育投注官网cejournal.com/news/international/2020/01/08/553871.htm

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