Knowledge is power, and investors need access to as much quality information as possible when making investment decisions. With a growing movement towards more ethical and sustainable business practices, not only for the greater good, but also to avoid risk, more transparency about companies’ performance in these areas is vital. The foundation of this movement is known as ESG.
Let’s take a closer look at what ESG is, and how you can use ESG scores to enhance your understanding of whether a particular company belongs in your portfolio.
What is ESG?
Also called sustainable investing, ethical investing or socially responsible investing, the initials ESG stand for environmental, social, and governance — issues according to which companies can be evaluated for their performance and then given a numeric rating.
ESG is one of the biggest investing trends today. Nearly 80% of investors are now pursuing or considering sustainable investment strategies, four out of five institutions are now integrating ESG considerations into their investment processes, and, as of 2020, 88% of publicly traded companies have ESG initiatives in place.
How can you use ESG scores in your investment decisions?
When considering which stocks to add to your portfolio, ESG scores, also known as ESG ratings, give you access to additional information about a company which is not usually accounted for in traditional financial analysis. Factors such as their risk exposure to climate change and human rights, for example, could have a significant impact on their stock’s performance.
Although ESG scores should not be relied on as the sole factor for making an investment decision, they can play a valuable role as part of your research and investment decision-making process. ESG scores can help guide you towards investing in companies whose sustainable practices make them better positioned to outperform over the long term, as well as help you to avoid companies involved in questionable or risky business practices.
As an investor, there are a number of ways you can use ESG scores to gain additional insights into how sustainable a company is:
- ESG scores can provide supplementary insights into a company beyond traditional financial analysis.
- ESG scores can be used as a filter to decide which stocks to include in your portfolio. For example, an investor might choose to invest only in those companies that have a high ESG score.
- ESG scores can act as a flag or monitoring tool. For example, a decrease in a company’s ESG score could be a signal to investigate what has triggered the change.
How are ESG ratings calculated?
Data, research, and analysis are likely already a part of your vocabulary as an investor. Much like how market analysis considers a company’s financial information to rank a stock, ESG scores consider specific factors to see how companies measure up in terms of sustainability.
The total ESG score is a composite of three separate scores, one for each category:
- Environmental factors take a company’s conservation efforts into account, including its energy efficiency level, carbon emissions, air and water pollution, waste management practices, and natural resource consumption.
- Social factors look at a company’s practices regarding people and community, such as its human rights and labour standards, workplace diversity, data privacy policies, and humanitarian contributions.
- Governance factors measure a company’s standards for management, such as its board composition, executives’ salaries, lobbying practices, and corruption prevention policies.
ESG on eToro
eToro is currently rolling out a new feature to provide ESG scores for thousands of stocks, so that our users can have clear and convenient access to this valuable information. The rollout will happen in stages, so if you don’t see the ESG scores on your app just yet, don’t worry — they are coming soon.
Unfortunately, there’s no one universally accepted ESG scoring system to guide investors, and ESG measurements can be quite subjective depending on who is calculating them. To ensure that eToro’s scores are as reliable as possible and reflect the most accurate information, we have partnered with ESG Book.
ESG Book is a global leader in ESG data analytics, used by top financial institutions to measure the sustainability performance of the world’s largest corporations. The company combines cutting-edge technology and research to make this data more widely accessible to the public. ESG Book takes companies’ self-reported information (published annually) into account as well as news and NGO signals on a continuous basis. This allows for the scores to be rebalanced daily and reflects any changes in the sustainability performance of a company, and thus, any change in score can be seen immediately on the eToro platform.
eToro’s ESG scoring system features a user-friendly “traffic light” colour scheme:
- A green score shows that the company is a leader in its sector in terms of ESG.
- An amber score shows that the company is average in its sector in terms of ESG.
- A red score shows that the company has a poor rating in terms of ESG, relative to its sector.
ESG is becoming increasingly popular because we, as a global society, give a lot more importance to ESG issues than ever before. Furthermore, studies have shown that companies which are more ESG-friendly tend to deliver more robust financial results over time. Therefore, investors are looking to ESG as a way of avoiding risks and as a potential source of better long-term returns. Discover for yourself how to use ESG scores when making your investment decisions.
This communication is general information and education purposes only and should not be taken as financial product advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial product. It has been prepared without taking your objectives, financial situation or needs into account. Any references to past performance and future indications are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.