ESG and Sustainability – What’s the Difference? – Techbytes

In recent months, more and more asset owners have been asking whether they should include environmental, social, and governance (ESG) issues in the investment decision-making process. This is because of the growing sensitization on the need to incorporate ESG criteria in the corporate environment.

Well, the first step for an investor is to differentiate between the ESG practices and sustainability goals.

Understanding ESG

ESG is an abbreviation for environmental, social, and governance issues. It refers to the factors of companies' operations that are not financial in nature but affect their long-term business success.

The term "environmental" refers to climate change mitigation or adaptation and other forms of environmental degradation.

The term "social" refers to both labor standards and the social relations in the supply chain (e.g., exploitation, child labor) as well as human rights, including gender equality and access to essential services (healthcare, water, etc.).

The term "governance" refers to the social and environmental performance of companies and the quality of governance structures that sit above them.

What is ESG, and how is it similar to Sustainability?

ESG is closely related to the Sustainability of business practices as they always go hand-in-hand with each other. The more sustainable a company's activities are, the higher its ESG rating. Typically, "Sustainable" is defined by the UN Global Compact as development that meets the needs of the present without compromising the ability of future generations to meet their own needs.

Sustainability involves both environmental and social issues as well as the company's long-term financial health. A sustainable company delivers value to society through ethical business behavior and is one that will be around for the long term. Typically, ESG and Sustainability have the following similarities:

• Both have a common goal to help companies and their shareholders do well without harming society or the environment.
• They both offer a solution to a problem in our lives; ESG can raise awareness about certain issues while Sustainability is more focused on stopping the problems from occurring rather than just making sure it doesn't worsen.

The Difference Between ESG and Sustainability

Now that we have defined ESG, let's look at the key differences between ESG and Sustainability:

1. First of all, ESG is an approach to investing that analyzes companies on environmental, social, and governance (ESG) factors — which are not related to climate change or environmental issues. This puts the focus on responsible behavior, fairness, and integrity.
2. ESG is about company identity, stakeholders, and decision-making — whereas Sustainability focuses on the relationship between the company and the environment.
3. ESG is a subset of Sustainability, but some companies would not be considered sustainable if they did not also have good ESG policies.
4. ESG is standardized — it's quantifiable on an index or on a scale from 0 to 100. This means you can benchmark your performance against other companies and get a sense of how you compare.
5. Sustainability is hard to measure and harder still to know if you're doing it well — since this is highly subjective and there's no consensus on what good performance looks like.
6. Sustainability focuses on the environment, climate change, and environmental issues — which can all be costly for companies to manage.
7. Another difference is that sustainable companies can include those with poor or even terrible ESG scores, whereas an ESG investment will not include a company with poor financials – this is often referred to as "the put": if you want to invest in the company, the ESG score must be in-line with your goals.
8. Finally, ESG is still an emerging field for most investors, while Sustainability has been around for long. Sustainability investing also tends to look at different types of metrics than ESG (such as economic profit). However, many investors are looking at how to combine ESG with Sustainability for the best portfolio returns.

Why ESG is here to stay: data-backed benefits

As the issue of Sustainability grows in importance, more and more companies are employing sustainable practices to improve their attractiveness to investors. The result is that it's not only the financial analysts focusing on company fundamentals but also ESG rating agencies. If a business is environmentally or socially responsible, it will be financially successful.

But don't take our word for it — let's look at the data:

According to Mercer, the US SIF Foundation, and Broadridge Financial Solutions study last year, ESG investment criteria can improve financial performance:

- 53% of respondents said their company's financial performance had improved since using ESG considerations in business strategies and capital allocation; and

- 52% reported that the market demand for sustainable investment products was increasing.

A 2016 study by the University of Cambridge and Boston Common Asset Management found that ESG considerations can improve a company's performance:

- companies with good ESG ratings have higher valuations than those with poor ones;

- companies with strong ESG practices have been more resilient to downturns in the market; and

- companies with strong ESG ratings have lower costs of capital, suggesting that financial markets view them as being more valuable.

Further proof comes from the 2017 study by CFA Institute (Chartered Financial Analyst):

-72% of surveyed investors said they would include ESG issues in their investment process within the following five years.

Transition to ESG

Integration of ESG factors in investment strategies is also considered by many as the shift towards sustainable investment. The main areas where investors seek to incorporate ESG include:

(1) Companies' environmental practices:

ESG investors believe that irresponsible environmental practices may adversely affect the intrinsic value of a company's stock, and therefore seek to make investments in large companies with good environmental records.

(2) Diversity and equality:

ESG investors believe that diversity and equality in the workplace can lead to a more productive workforce.

(3) Human rights:

ESES investors believe that allowing employees to exercise their human rights freely increases the employee's level of satisfaction and thus productivity.

(4) Anti-corruption measures:

ESG investors believe that companies with anti-corruption measures have a competitive advantage over companies without.

(5) Company's governance practices:

ESG investors believe that good corporate governance practices contribute to a company's stability, provide it with a competitive advantage, and increase its share price.