8 ESG investment strategies to explore

8 ESG investment strategies to explore

As concerns about the environment rise globally, many investors look for companies that address these concerns. Environmental, social, and governance (ESG) investing is still relatively new, and there are formal guidelines for incorporating it into investment decisions. So, asset managers must determine the approaches that most closely align with their objectives. When building an ESG portfolio, it is important to remember eight crucial investment approaches.

ESG integration
It positions companies with high material ESG ratings as investment-worthy to boost portfolio return. Instead of defining a fixed set of rules, like the negative and positive screening, this strategy embeds ESG considerations into the company’s prevailing investment process. It is one of the top ESG investment strategies to consider for favorable returns. However, please update the procedures to account for the ESG factors for implementing this strategy.

For instance, employing the ESG risk scoring model, a fund comprises weighted shares for top-performing companies for various governance, social, and environmental criteria and financial performance across the broad spectrum.

Corporate engagement and shareholder action
It involves using the shareholder’s power to influence corporate behavior, including:

  • Direct corporate engagement, meaning interacting with the board of companies or senior management
  • Co-filing or filing shareholder procedures
  • Proxy voting guided by comprehensive ESG guidelines

Report how shareholder voting and engagement address ESG risks and clearly define the engagement goals. For instance, a group of investors passed a resolution to appoint new board directors who showcase expertise in climate change action for a gas and oil company.

Norms-based screening
Investors take strides in promoting international norms and standards by excluding companies involved in activities like:

  • Corruption
  • Human right abuses
  • Environmental destruction

United Nations Global Compact principles guide this strategy. Further, they adhere to international norms, like those issued by NGOs, the International Labour Organization, and the Organization for Economic Co-operation and Development. By avoiding such firms, one can contribute to global progress. For instance, the pension fund demands investments to adhere to the ISO 45001 health and safety standards.

Negative screening
Also called exclusionary screening, negative screening enables investors to pick companies from their investment portfolio based on ESG criteria, like:

  • fossil fuel producers
  • weapon makers

It facilitates individuals to avoid businesses linked to products of contention or damaging practices. The idea is to determine the exclusion criteria upfront based on a specific goal. For instance, the vision is to reduce climate change’s impact. So, one can avoid all fossil fuel companies from investment portfolios.

Positive screening
Also called best-in-class screening, positive screening involves picking a subset of top-performing companies from a specified industry and a set of characteristics to invest in. Naturally, it is the converse of negative screening. So, instead of setting criteria to exclude the companies, one can set performance measures to choose the top performers.

For instance:

  • Invest money in the five appliance companies with the most diverse board of directors
  • or top 10 apparel companies having the lowest carbon footprint

Thematic investing
Also called sustainability-themed investing, thematic investing is a strategy wherein the investors identify one issue linked to sustainability and put money in indexes of firms that address it, such as:

  • Gender equity
  • Green buildings
  • Lower carbon-tilted portfolio
  • Sustainable agriculture
  • Diversity

As part of this investing strategy, the asset managers must communicate whether their investments apply a lens to the broad economic base. Like positive screening, thematic investing focuses on index creation instead of picking top-performing companies. While positive screening can apply to any ESG factor, thematic investing is curtailed to environmental issues.

For instance, an ETF comprising all publicly listed renewable energy companies in the area. Alternatively, one gathers an index of companies with superior waste management if one is exquisitely centered on waste management across various risk levels and sectors to ensure the planet’s health.

Portfolio Tilt
It is a strategy in which the investor tilts the ESG investment percentage in a portfolio to ensure it is higher than the non-ESG investments while keeping the sector weights matching the target index.

For instance, one wishes to match the Russell 3000 index. So, one can tilt tactics and pick investments from across the index to keep the risk level at par with the index. Ensure one has more highly rated companies on the ESG metrics than poorly rated ones.

It is a relatively low-risk investment strategy that meets the ESG goals. Negative and positive screening, though effective at targeting the ESG goals, do not offer a comprehensive industry variety and exhibit greater risk.

Low-carbon investing
Some investors regard global warming as a systemic financial risk. It has resulted in an increased focus on investors examining climate change threats to their assets. Low-carbon investing is one of the top strategies to cater to this issue in the portfolio. Under this approach, one can invest in companies with lower carbon emissions or those drifting to a more eco-friendly or sustainable business model. Some approaches to this investment strategy include:

  • Divesting from companies owning fossil-fuel reserves
  • Investing in companies contributing to decarbonization

So, when determining where to invest, assess whether the company has established clear emission reduction targets. Companies with well-defined and ambitious goals demonstrate a commitment to lowering carbon impact over time.