by Tommaso Motta
ESG Investment Strategies: how they make financial sense
What does ESG mean?
ESG stands for Environment, Social and Governance, and are a new set of criteria that socially conscious investors tend to use in order to select a potential company for their investments. Environmental factors aim at evaluating a company for the grade of involvement into environmental issues, that now more than ever are becoming increasingly relevant for the wellness of mankind, and thus investors tend to be more aware and invest in companies that are compliant with their environmental values. Example of environmental issues are: waste management politics, use of renewable resources, energy management, cut of greenhouse emissions and promotion of decarbonizing activities. Social factors are more imbedded in our society, since in the past there have been many social revolutions that aimed specifically at pointing out social injustices within a company or a group (a famous example would be the 2004 scandal of Nike using children workforce), and thus we tend to be indignant whenever human rights are violated or more generally, company abuse their workforce. Governance factors refers to a set of rules or principles defining rights, responsibilities, and expectations between different stakeholders in the governance of corporations. With governance, investors want to know that a company uses accurate and transparent accounting methods and that stockholders are given an opportunity to vote on important issues. They may also want assurances that companies avoid conflict of interest in their choice of board members and do not engage in illegal practices. In fact, a well-defined corporate governance system can be used to balance or align interests between stakeholders and can work as a tool to support a company’s long-term strategy.
How does an ESG strategy work?
With the term ESG strategy we intend an investing strategy where the portfolio composition of the investor is mostly made up by socially responsible investments. But, in order to do so, it is necessary to define whether a certain company falls in this definition, and this is made possible through the use of FinScience’s ESG score methodology. It is a process structured into three main phases:
- Data gathering. This phase involves the collection of data from different web sources: websites, social network pages, news, or blogs. Then, the contents are extracted from the web pages and are pre-processed via a first level of data cleaning for the elimination of noise and the extraction of the main body: this is the input to the next phase of data processing.
- Data processing. At this stage, Natural Language Processing (NLP) methods are carried out. The contents collected in the data gathering phase are subjected to an NLP analysis that allows to determine the objects (companies and SDG topics…) disseminated and discussed on the web.
- Data enrichment and analysis. Once the topics covered have been identified, the data are analysed, normalised and enriched to obtain further metrics such as: Digital popularity Value (DPV): a measure of the diffusion of a digital signal on the web. It is obtained by aggregating the diffusion metrics of the news mentioning the signal at hand. Sentiment: it measures how users feel about a specific company or information. This indicator seeks to quantify how current beliefs and positions affect future behaviours. The sentiment value – weighted by DPV – is finally assigned to reflect the public perception of corporate sustainability efforts/impact.
Pros and cons of ESG investing strategies
ESG funds, also known as socially responsible investments are a particular type of investments that typically either fully convinces an investor or makes him immediately flee from it. As for many other types of investments there is no final answer whether or not ESG investments are generally good or bad; what we can do is create a list of pro and cons, that each investor should evaluate before committing.
First of all, it is about to taking a stand. It is easy to complain, but definitely harder to do anything about it. When investing in socially responsible investing we are signalling that we support the values of a company and at the same time that something needs to change to business that are not behaving correctly. And even though it might sound utopistic (surely business do not mind only one single, small investor withholding his money to pursue his values), it is still a starting point to a change; if nobody took a stand, no changes would ever happen. But it is not only a matter of punishing the “bad companies”, it is also a way to promote and reward those business which are actively trying to make this world a better place, which should, by any means, make the investor proud of his action, and if this is combined with making money, it is just a win-win situation.
As a folk’s proverb reminds us, “it is not all gold what shines”, in fact it is absolutely possible that being focused only on socially responsible investments leads to leaving some more profitable investments or to an overpayment of the ESG funds due to being seen as an added value (while the company might perform worse than other competitors). Moreover, there is the problem that many companies claim to be socially responsible while in reality they are not, because in many cases it is more important to be seen as rather than to actually be socially responsible. Or even, in some small cases, the definition of socially responsible might be fallacious, since depending on the point of view of the investor, it might be seen as responsible or as irresponsible.