# Environmental, Social, and Governance (ESG) Investing: What It Is & How It Works

> **Definition**
>
> Environmental, social, and governance (ESG) investing involves evaluating a company for investment based on its performance related to environmental, social, and governance criteria.

## What Is Environmental, Social, and Governance (ESG) Investing?

ESG stands for environmental, social, and governance. [ESG investing](https://www.investopedia.com/how-to-have-better-esg-conversations-5323841) refers to an investing approach that prioritizes how companies score on these metrics. Environmental criteria gauge how a company safeguards the environment. Social criteria examine how it manages relationships with employees, suppliers, customers, and communities. Governance measures a company’s leadership, [executive pay](https://www.investopedia.com/articles/stocks/07/executive_compensation.asp), [audits](https://www.investopedia.com/terms/a/audit.asp), [internal controls](https://www.investopedia.com/terms/i/internalcontrols.asp), and [shareholder rights](https://www.investopedia.com/investing/know-your-shareholder-rights/).

### Key Takeaways

*   Environmental, social, and governance (ESG) investing involves screening investments based on corporate policies, encouraging companies to act responsibly.
*   Many [brokerage firms](https://www.investopedia.com/best-online-brokers-4587872) offer investment products that employ ESG principles.
*   ESG investing can help portfolios avoid holding companies engaged in risky or unethical practices.

![Environmental, Social, and Governance (ESG) Criteria](https://www.investopedia.com/thmb/ILZB8hYwyeS4MVpZCbZ_yRcc9pQ=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/ESG-final-fc9c8799d2d34234a895cbab621c21ad.png)

*Firms that measure ESG compliance typically dismiss investments tied to harmful industries. — Investopedia / Julie Bang*

## How Environmental, Social, and Governance (ESG) Investing Works

Environmental, social, and governance (ESG) investing is sometimes referred to as [sustainable](https://www.investopedia.com/terms/s/sustainability.asp) investing, responsible investing, [impact investing](https://www.investopedia.com/investing-for-sustainability-impact-5210477), or [socially responsible investing (SRI)](https://www.investopedia.com/terms/s/sri.asp). To assess a company based on ESG criteria, investors look at a broad range of behaviors and policies. ESG investors seek to ensure the companies they fund are responsible stewards of the environment, [good corporate citizens](https://www.investopedia.com/ask/answers/041015/why-social-responsibility-important-business.asp), and are led by accountable managers.

*   **Environmental**: Investors evaluate corporate climate policies, energy use, waste, pollution, natural resource conservation, and animal treatment. Considerations might also include direct and indirect [greenhouse gas emissions](https://www.investopedia.com/investing-in-pollution-control-and-waste-reduction-5220620), management of toxic waste, and compliance with environmental regulations.
*   **Social**: This is how a company's relationships with internal and external [stakeholders](https://www.investopedia.com/terms/s/stakeholder.asp) are evaluated. Does the company donate a percentage of profits to the local community or encourage employees to volunteer? Do workplace conditions reflect a high regard for employees’ health and safety?
*   **Governance**: This ensures a company uses accurate and transparent accounting methods, pursues integrity and diversity in selecting its leadership, and is accountable to shareholders. ESG investors might require assurances that companies avoid [conflicts of interest](https://www.investopedia.com/terms/c/conflict-of-interest.asp) in their choice of board members and senior executives, in addition to not using political contributions to obtain preferential treatment or engage in illegal conduct.

ESG investors help inform the investment choices of large institutional investors such as public pension funds. In Q4'24, sustainable funds reached $3.2 trillion in [assets under management (AUM)](https://www.investopedia.com/terms/a/aum.asp) globally, according to a report from the Morningstar. Brokerage and mutual fund companies offer [exchange-traded funds (ETFs)](https://www.investopedia.com/terms/e/etf.asp) and other financial products that follow ESG investing strategies. [Robo-advisors](https://www.investopedia.com/terms/r/roboadvisor-roboadviser.asp), including [Betterment](https://www.investopedia.com/betterment-review-4587887) and [Wealthfront](https://www.investopedia.com/wealthfront-review-4587933), have promoted these ESG-themed offerings to younger investors.

> **Important**
>
> SRI is an investment strategy highlighting one facet of ESG. SRI investors seek companies that promote ethical and socially conscious issues, including diversity, inclusion, community focus, social justice, and corporate ethics.

## ESG Metrics

Investment firms, such as Trillium Asset Management, use a variety of ESG factors to help identify companies positioned for strong long-term performance. The criteria are set by analysts who identify the relevant issues facing specific sectors, industries, and companies.

Some of the positive qualities Trillium looks for when evaluating companies include limiting harmful pollutants and chemicals, using renewable energy sources, paying employees a fair wage, operating with an ethical supply chain, maintaining a diverse board, and demonstrating corporate transparency.

Trillium's ESG criteria preclude investments in companies that earn 5% or more of their revenues directly from coal mining or hard rock mining, gambling, tobacco, private prisons, and weapons. The firm doesn't invest in companies involved in major controversies related to human rights, animal welfare, environmental concerns, governance issues, or product safety.

## Investors and ESG

As ESG business practices gain traction, investment firms track their performance. Financial services companies, such as JPMorgan Chase ([JPM](https://www.investopedia.com/markets/quote?tvwidgetsymbol=jpm)), Wells Fargo ([WFC](https://www.investopedia.com/markets/quote?tvwidgetsymbol=wfc)), and Goldman Sachs ([GS](https://www.investopedia.com/markets/quote?tvwidgetsymbol=gs)), publish annual reports that extensively review their ESG approaches and the bottom-line results.

The ultimate value of ESG investing depends on whether it encourages companies to drive real change for the common good or merely check boxes and publish reports. That, in turn, will depend on whether the investment flows follow ESG tenets that are realistic, measurable, and actionable.  

Tobacco and defense are two industries avoided by many ESG investors, but they've historically produced above-average market returns and can buck recessionary trends. To support ESG, investors may be sacrificing returns in exchange for values. Many ESG investors are willing to make that tradeoff, however; according to a [survey](https://www.investopedia.com/pollution-and-working-conditions-top-esg-investor-concerns-5193407) of _Investopedia_ and _Treehugger_ readers, nearly half of ESG investors said they'd be willing to take a 10% loss over five years to invest in a company that “aligns exceptionally against ESG standards.” But 74% of respondents said that valuation/price was “very or extremely important to them.”

## What Does Environmental, Social, and Governance (ESG) Mean for a Business?

Adopting environmental, social, and governance (ESG) principles means a business' corporate strategy includes ethical environmental, social, and governance policies. This means taking measures to lower pollution and carbon dioxide output, giving back to the local community, as well as having a diverse and inclusive workforce (both at the entry level and on the board of directors), among other efforts.

## How Is ESG Investing Different From Sustainable Investing?

ESG and sustainability are closely related. ESG investing screens [companies based on criteria](https://www.investopedia.com/b-corp-7488828) related to social justice, environmental concerns, and good corporate governance. Together, these features can lead to sustainability. ESG, therefore, looks at how a company's management and stakeholders make decisions; sustainability considers the impact of those decisions on the world.

## How Do I Know Which Investments Are ESG?

Several financial firms have ESG ratings and scoring systems. For instance, as of June 30, 2024, [MSCI has a rating scheme](https://www.investopedia.com/msci-esg-ratings-5111990) covering over 17,000 companies, giving them scores and letter grades based on their compliance with ESG standards and [initiatives](https://www.investopedia.com/net-zero-asset-managers-initiative-5224453). Several other companies, such as Morningstar and Bloomberg, have also created [criteria for scoring companies](https://www.investopedia.com/company-esg-score-7480372) based on ESG objectives.

## The Bottom Line

Environmental, social, and governance (ESG) investing focuses on companies that follow positive environmental, social, and governance principles. Investors are increasingly eager to [align their portfolios with ESG-related companies](https://www.investopedia.com/terms/f/ftse4good-index.asp) and fund providers, making it an area of growth with [positive effects on society and the environment](https://www.investopedia.com/articles/investing/061014/impact-investing-making-difference-and-profit.asp).

> **Article Sources**
>
> 1.  S&P Global. "[Understanding the 'E' in ESG](https://www.spglobal.com/en/research-insights/articles/understanding-the-e-in-esg)."
>     
> 2.  Harvard Law School Forum on Corporate Governance. "[Time to Rethink the S in ESG](https://corpgov.law.harvard.edu/2020/06/28/time-to-rethink-the-s-in-esg/)."
>     
> 3.  S&P Global. "[What Is the 'G' in ESG?](https://www.spglobal.com/en/research-insights/articles/what-is-the-g-in-esg)"
>     
> 4.  Morningstar. "[Global ESG Fund Flows Increase in Q4](https://www.morningstar.com/sustainable-investing/global-esg-fund-flows-increase-q4)."
>     
> 5.  Trillium Asset Management. "[ESG Integration & Criteria](https://www.trilliuminvest.com/esg/esg-integration-criteria)."
>     
> 6.  Goldman Sachs. "[Sustainability Reporting](https://www.goldmansachs.com/investor-relations/corporate-governance/sustainability-reporting/)."
>     
> 7.  Wells Fargo. "[Goals and Reporting](https://www.wellsfargo.com/about/corporate-responsibility/goals-and-reporting/)."
>     
> 8.  JP Morgan Chase. "[Environmental, Social and Governance](https://institute.jpmorganchase.com/about/governance/esg)."
>     
> 9.  ESG Analytics. "[Green, Blue, Pink and Social Corporate Washing](https://www.esganalytics.io/insights/social-green-blue-pink-washing#toc-how-corporations-are-misleading-esg-investors)."
>     
> 10.  MSCI. "[ESG Ratings](https://www.msci.com/our-solutions/esg-investing/esg-ratings)."
>      
> 11.  Morningstar. "[Surfacing ESG Data and Research](https://www.morningstar.com/products/direct/esg-data)."
>      
> 12.  Bloomberg. “[Environmental, Social & Governance (ESG): Bloomberg Professional Solutions](https://www.bloomberg.com/professional/solution/sustainable-finance/?_ga=2.91760346.1164475546.1681407376-1360313546.1681407376).”