Investment management is known for its bevy of TLAs (Three Letter Acronyms). Some of them you may have heard before such as SAA (Strategic Asset Allocation), MER (Management Expense Ratio), NAV (Net Asset Value) or even ETF (Exchange Traded Fund).
Another TLA that has been receiving a great deal of coverage in the media is ‘ESG’ which stands for Environmental, Social and Governance. ESG refers to three factors that are sometimes used in evaluating an investment, in addition to traditional performance metrics.
Many investors today are keen to make investment choices that align with their broader values – for example, ensuring that the companies they are investing in are paying their employees fairly and offering suitable working conditions, not damaging the environment through the production or supply chain process, and adhering to corporate policies.
What is the E in ESG?
Environmental factors can focus on pollution generated, waste management practices, resource utilisation, carbon emissions, supply chain management, and impact on climate change.
What is the S in ESG?
Social factors might be concerned with how companies respect employees and people in the wider community. Relevant factors include workplace diversity, labour practices, working conditions, and work health and safety.
What is the G in ESG?
Governance factors include corporate policies and company governance practices. Tax strategy, data security, product safety, executive compensation, donations, lobbying, bribery, misconduct, business ethics, culture, innovation, and board diversity could be relevant.
To help you navigate the ethical investing landscape, we have put together a glossary of a few terms you might come across:
- Carbon emissions: refers to the release of greenhouse gas emissions in the atmosphere, created by burning fuel for power or heat. Carbon emissions are categorised into Scope 1, 2, 3, or 4 to describe where in the value chain these emissions are being produced.
- Carbon footprint: the amount of greenhouse gas emissions generated by a corporation in the course of producing goods or providing services.
- Clean technology: refers to products and services using renewable energy to reduce waste and minimise the use of natural resources.
- Engagement: Fund managers who are significant shareholders of a company are encouraged to evaluate ESG factors that currently are not being addressed, and proactively communicate with these companies with a view to drive positive change.
- Green bond: bonds that are issued to fund environmental or climate change projects. This can include projects designed to prevent or reduce pollution, improve the sustainable use of natural resources, or help in the transition to cleaner, non fossil fuel-based technologies.
- Greenwashing: From a financial services perspective, this is includes the act of misrepresenting the ethical credentials of a fund – for example, if an Australian equity fund markets itself is marketed as being free of armaments exposure, when in reality there are no armaments companies in Australia.
- Impact investing: investing with the goal of making a positive, measurable contribution to society or the environment, whilst also generating a financial gain.
- Modern slavery: encompasses the exploitation of people who are employed by a company. This can include forced labour, underpayment of wages and human trafficking. Modern slavery is a qualitative negative screen and as such industry and agency reports are used as a means to evaluate company conduct company.
- Negative screening: process of excluding companies that have exposure to certain industries or sectors that are deemed to have a negative impact on society. Negative screens are often used to exclude companies involved in the production of tobacco, fossil fuel exposure, armaments and other ethically questionable activities.
- Positive screening: process of including companies that perform well or make an impact on certain ESG metrics or values compared to industry peers.
- PRI: stands for Principles for Responsible Investment. The PRI, which is supported by the United Nations, comprises six investment principles that can act as a guide for incorporating ESG incorporation issues for investment managersinto investment practice. Investment managers can become signatories to the PRI which indicates their commitment to the Principles.
- Proxy voting: Voting on behalf of a shareholder. Fund managers who are large shareholders in a company can use their votes to influence companies on ESG matters and are increasingly encouraged by their investors to do so.
- Renewable energy: refers to energy produced from natural resources that can be constantly renewed without concerns about depletion. Examples of renewable energy include solar, wind and hydropower.
- Scope 1 emissions: Direct emissions produced by companies in the course of their day-to-day activities, e.g. by company vehicles and facilities.
- Scope 2 emissions: Indirect emissions generated by the company from using energy, e.g. the emissions from burning coal produced as the result of the company’s use of electricity.
- Scope 3 emissions: Indirect emissions by the company from the wider value chain. The assets in the value chain are not owned or controlled by the company, e.g. franchise businesses, waste, usage of sold products.
- Scope 4 emissions: Defined as being avoided emissions from a company that occur outside of the value chain but as a result of using the end product,. Ee.g. a company that provides teleconferencing services results in avoided emissions from workers staying at home instead of commuting into an office or traveling to meet clients
- Transition risk: refers to the risks facing companies as they move towards less pollution and the adoption of more renewable energies – in the course of this transition, some assets currently held by these companies could potentially lose their value. For example, if governments move to ban the burning of fossil fuels, energy companies with exposure to coal and gas facilities may face asset devaluations.
These definitions certainly don’t cover all of the terminology used in the ethical segment, but hopefully will be useful as a reference as you continue your ESG investment journey.