ESG Investing For Dummies

Brendan Bradley is co-author of FinTech For Dummies. He fosters and develops support for new ­investment areas, including AI-assisted research for automated modeling and transforming ­unstructured financial content in the ESG ecosystem.

• Introduction 1About This Book 1Foolish Assumptions 2Icons Used in This Book 3Beyond the Book 3Where to Go from Here 3Part 1: Getting to Know ESG 5Chapter 1: Entering the World of ESG Investing 7Surveying the Current ESG Landscape 8Exploring What ESG Is (and Isn’t) 9Defining the breadth of ESG 10Comparing SRI, ethical, and impact investing to ESG 14Determining whether ESG delivers good investment performance 16Understanding ESG’s Impact on the Environment, Society, and Governance 17Meeting environmental and global warming targets 17Providing solutions to social challenges 18Meeting corporate governance requirements 18Using International Standards to Determine ESG Objectives 19Leading the charge: European legislation on ESG 20Ahead of its time: The United Nations 21Staying focused: The Sustainability Accounting Standards Board 21Building a framework: The Global Reporting Initiative 22Chapter 2: Back to the Future: Understanding the Evolution and Growth of ESG Investing 23Studying the Evolution of Investing in ESG 24Investing through the ages: From SRI to ESG 24Go green: The changing global environment 27On trend: Changing investor demographics 28Crunch the numbers: Evolving data and analytics 29Exploring the “Personality” of an ESG Company 31Determining material ESG factors 31Performing a materiality analysis 32Applying weights to materiality measures 33Understanding Why ESG Is Important 34Global sustainability challenges 35The interest of millennial investors in ESG 35More systematic, quantitative, objective, and financially relevant approaches 36Surveying Specific ESG Ratings and Metrics 36Data quality, ratings bias, and standardization 37Issues with ESG scoring 38ESG momentum importance 39Applying artificial intelligence and data science to ESG analysis 39Defining an ESG Policy 40Familiarize yourself with ESG and asset owner–specific legislation 40Undertake a peer review 41Review your statement of investment beliefs and core investment principles 41Specify responsible investment guidelines 41Outline responsible investment procedures 42Include engagement and active ownership approaches 42Spell out reporting requirements 43Chapter 3: Give Me an ‘E’! Defining the Environmental Sector in ESG 45Outlining a Company’s Use of Natural Resources 46CO2 or GHG? Climate change and carbon emissions 46Clean and green: Energy efficiency 48A crisis awaits: Conservation of water 49There is no Planet B: Air and water pollution 50Live and let live: Biodiversity 51See the forest for the trees: Deforestation 52Don’t throw your future away: Waste management 54Studying the Effects of a Company’s Operations on the Environment 55Direct operations 55Supply chains 56Defining “Green” for a Company 57Internalizing (or managing) externalities 58The 3Rs: Reduce, reuse, and recycle 58Detailing a Company’s Performance as a Steward of the Physical Environment 60Managing operations to reduce emissions and promote sustainability 61Collaborating with others to create solutions for environmental issues 61Chapter 4: Give Me an ‘S’! Investigating the Social Aspects of ESG 63Identifying Factors in a Company’s Social Performance 65Customer satisfaction 65Data protection and privacy 66Gender and diversity 68Employee engagement 69Community relations 70Human rights 71Labor standards 72Evaluating a Company’s Social Performance 73The results are in: Achievements 74When in Rome: Differentiating on a national or regional basis 75Determining Measurements for Social Performance 75The alignment of social and economic responsibilities 76Long-term change for people and communities 77Deciding on Weight Factors 78Take your pick: Different social issues 78Think outside the box: Scenario analysis 79Chapter 5: Give Me a ‘G’! Decoding the Governance Component of ESG 83The Good Place: Defining What “Good” Corporate Governance Looks Like 84The benefits of good governance 85Practices and values 86Multiple stakeholder orientation 87Walk the Walk: Evaluating a Company’s Governance Values 88Board responsibilities 89Board composition 90Audit committee structure 90Bribery and corruption 92Executive compensation 94Lobbying 95Political contributions 96Whistleblower schemes 97Lead the Way: Emphasizing How ‘G’ Can Dictate the ‘E’ and ‘S’ Factors 98Governance as an overarching principle for ESG 98The role of governments 100Around the World: Underlining Regional Differences in Governance Activities 101Emerging markets 102North America 104Europe 105Chapter 6: Highlighting Corporate Greenwashing 107The Grass Isn’t Always Greener: The Basics of Greenwashing 108Tracking the growth of greenwashing 108Specifying the details 109Using plain language 110Setting up a system 112Just When You Thought It Was Safe: Coronawashing 113Coronawashing on the corporate side 113Coronawashing on the investor side 114Part 2: Investing in ESG through Different Instruments 117Chapter 7: Approaches to ESG Investing 119Understanding Socially Responsible Investing 120Looking at reasons for SRI 120Comparing a best-in-class strategy to an exclusion strategy 121Weighing the potential return on SRI decisions 122Evaluating Impact Investing 124Defining and tracking “impact” 124Measuring social and environmental outcome targets 126Calculating impact metrics 127Focusing on Faith-Based Investing 128Reviewing religious principles of finance 128Examining exclusion screening and divesting 129Advocating for values through proxy voting 130Chapter 8: Analyzing Equity-Based Instruments 133Integrating ESG Strategies into Investment Decisions 134Just the basics: Getting an overview of the process 134Using active strategies 136Analyzing the impact of different ESG scores 137Watch out: Thinking about risks and disclosures 138Investigating how companies with higher ESG scores outperform 139Take it easy: Applying passive strategies 140Reviewing relative returns and performance of ESG stocks 143Verifying Quantitative Strategies 145Constructing equity portfolios that integrate ESG factors 146Adjusting stock index constituent weights 148Determining which ESG factors matter most in quantitative strategies 148Identifying Smart Beta Strategies 151Extending negative stock screening to smart beta strategies 153Using ESG equity factors and scores to weight portfolio construction 153Focusing on a Given Theme 154Sector exposure 154Thematic exposure 155Chapter 9: ESG and Fixed Income Instruments 157Analyzing Fixed Income (Bond) Factors 158The importance of risk 158Strategies for adding ESG to fixed income portfolios 159Bond issuer goals 160Defraying interest rate costs 161All together now: ESG integration issues 162Bond pricing 163Mix it up: Credit and ESG ratings 164Emphasizing Bond Issuer Differences 165For king and country: Sovereign issuance 166Corporate issuance 168Room for more: Emerging markets 168Highlighting Fixed Income Indexes 169Identifying Specific ESG Exposures 171For the earth: Green bonds 172Think big: Social bonds 174Keep it up: Sustainability and sustainability-linked bonds 175Chapter 10: Exploring Derivative and Alternative Instruments 177Achieving Passive Returns Using ESG Indexes 178The basics of exchange-traded products 179OTC derivatives 180Building blocks: Structured products 181Increasing Focus on ESG in Alternative Assets 182Sustainable lending 182ESG in hedge funds 184Focusing on Illiquid Assets 186Around the block: Real estate 186Laying foundations: Infrastructure 187Hush-hush: Private equity 188Investing in “Traditional” ESG 189Pull the plug: The basics of renewable energy investment 190Light my fire: Solar power 191There she blows: Wind power 192Chapter 11: Highlighting Geographical Differences in ESG Investing 195The Beginning: Europe 196Highlighting the regulatory developments 198Enjoying a first mover advantage on ESG investment 201Continuing inflows for ESG funds 202The Middle: North America 203Highlighting political and regulatory roadblocks in the United States 204Investigating Canada’s approach 206Driving up demand 207The End: Developed versus Emerging Markets 208Seeing that emerging markets are lagging but disclosure is increasing 209Highlighting political and regulatory developments 211Determining whether an ESG approach is better suited to developed economies 212Part 3: Applying ESG Philosophy 215Chapter 12: Creating Value through ESG for Corporations 217Crystal Clear: Corporate Disclosure and Transparency 218Meet the team: ESG engagement 219Thank you for sharing: Communication from the board 221Grow the Pie: Generating Enhanced Returns 221Increasing access to capital 222Corporate adoption and action 223Roll Up, Roll Up: Attracting More Customers 224Tracking sustainability practices 225Measuring intangible value drivers 226Identifying material opportunities 227Pare It Back: Reducing Costs 228Green financing 228How low can you go? Lower interest rates and higher credit ratings 229The Bottom Line: Increasing Productivity and Attracting Talent 230Chapter 13: Devising an ESG Policy 233Here’s a Great Idea: Creating a Plan 234Promoting ESG among key stakeholders 235Creating an internal governance structure 235Don’t Reinvent the Wheel: Undertaking a Peer Review 236Devising ESG investment strategies 236Identifying, assessing, and selecting ESG investments 238Go Over It: Reviewing Your Core Investment Principles 238Familiarizing Yourself with ESG-Specific Regulations 240Comparing Europe and the United States 240Taking into account sustainability-related risks 241Doing effective due diligence on ESG greenwashing 242Surveying Reporting Requirements 243Essential characteristics of ESG data 244Material factors for investors 244Examining ESG Engagement 245Conducting constructive dialogue on managing ESG risks 245Seizing business opportunities associated with sustainability challenges 246Chapter 14: Defining and Measuring ESG Performance and Reporting 249Defining Criteria and Metrics 250Follow the rules: Looking at regulators’ work 251The devil is in the details: Analyzing corporate sustainability reports 252Walk the walk: Committing to corporate social responsibility practices 253Show me the money: Identifying investment performance 254Calculating Relative ESG Performance 255Against the broader market 257Against specific benchmarks 258Getting a Handle on Ratings and Rankings 259Securities 260Portfolios 261Not the sharpest tool: Smart beta 262Developing Frameworks for Reporting 262In your view: ESG objectives 263Play by the rules: ESG compliance 265Meet the players: Comparing different frameworks 265Chapter 15: Elaborating the ESG Endgame 269Highlighting the Evolution of ESG from Niche to Mainstream Strategy 269Achieving competitive financial returns with positive ESG impact 270Emphasizing the need for common terminology 271Watching the Growing Use and Acceptance of ESG Standards 272Digging into disclosures 272Providing data consistency 274Developing national and international financial reporting standards 275Looking at the Increasing Impact of ESG Ratings and Rankings 278Qualitative decisions 279Quantitative decisions 280Improving Education 281What do investors believe is important? 282What should a company know about its ESG rating? 283Part 4: The Part of Tens 285Chapter 16: Ten Frequently Asked Questions for an ESG Approach 287What Is ESG Investing? 287Which Sustainability Goals Should Be Followed? 288What Are the Characteristics of an ESG Company? 289How Is an ESG Company Rated? 290What Investing Principles Should Be Adopted for ESG? 291What Is Stewardship? 292How Is an ESG Approach for Asset Owners Implemented? 293How Are Benchmarks and Performance Measurement Incorporated in ESG? 293What’s the Latest on Disclosures and Reporting? 294What’s the Future of ESG Investing? 295Chapter 17: Ten Issues Surrounding ESG Portfolio Construction 297Reasons for Varying ESG Scores between Rating Agencies 297Criteria Used in Creating a Combined ESG Score 298Trends Driving ESG Materiality 299Quantitative Approaches to ESG Analysis 300Qualitative Analysis: Verifying and Supplementing Quantitative Analysis 301ESG Regulations 302Risk and Reward 303Derivative and Alternative Instruments 304Stranded Assets 305Sustainable Investing 306Chapter 18: Ten Factors Influencing the Growth of ESG Investing 307Climate Change: The Route to Net Zero 308Environmental and Social Issues Coming to the Fore 308Stewardship as a Driver for Change 309ESG Disclosures 310Accounting 311Regulation and International Standards 312Impact Investing: Actively Do Good versus “Do No Harm” 313Data and Technology 314Consolidation of the ESG Ratings Companies 315Political Impacts: Geopolitics and Public Pressure 316Appendix: Great Resources For ESG Investing 319Index 327