Environment, Social, Governance
Morningstar's Hale notes that ESG ratings take an industrywide look at companies and evaluate how each company is doing on environmental, social and corporate governance issues within its industry.
The environmental rating looks at what the most significant material environmental issues are that a company has to deal with in its particular industry.
On the social side, it mainly considers how a company treats workers, supply chain oversight, general product safety and other topics.
Corporate governance looks at how a company is governed, focusing on issues like executive compensation, separation between president and chief executive officer, and board diversity.
Hale says it's possible to mix ESG factors and use the abovementioned SRI exclusionary screening. Usually the focus with ESG is to take a more holistic approach and use positive screening that's rewarding companies for making strides in their industry.
ESG funds can also have some themes like water or alternative energy, and having the ESG criteria can help with factoring in companies developing sustainable products, he says.
These criteria are also tangible to investors. For instance, an investor might be interested in a fund containing Tesla because it's on the cutting edge of electric cars and battery technology. However, when looking holistically at the company, it may have ESG issues, because developing batteries uses a number of caustic chemicals.
The big difference in goals with ESG versus SRI is that ESG is driven by financial performance, Kuh notes.
"The idea is that you can incorporate ESG into your investment process and improve financial outcomes by enhancing long-term returns or reducing risk. What we've seen is there is a good deal of evidence in the academic and practitioner iterations that integration approaches don't hurt performance; rather, they tend to improve them. What that does for institutions is it opens them up. It addresses concerns investors might have about performance," he explained.
Impact investing is still emerging, but it started as an idea that some investors want to have a high social or environmental conviction with their investment in addition to strong financial return. Sometimes in this type of investing there's a term called "triple bottom line," which focuses on people, planet and profit, and tries to give each equal footing when it comes to business operations.
This can include companies that are making sustainable products, and positive screens can include companies that are striving toward all goals, Hale notes.
Not only is the impact category younger, it reflects this new trend of a company aiming to be profitable and do well for society or the environment.
"Things in this category may generate substantial revenues from activities, that, for example, align with the United Nations' sustainability goals," Chardonnens said.