Understanding ESG Investing
Learn how you can best position yourself for success
Updated 
5 min. read
Like many Canadians, you want to invest for a better future for yourself and your family. But you may wonder, how will your investments be used? That’s where ESG investing comes in.
Is ESG investing the same thing as responsible investing?
Environmental, social and governance (ESG) factors are key considerations used by investment decision makers for responsible investing. There are five types of responsible investing:
- Integration: Integrating ESG factors within the investment decision process, along with traditional financial analysis.
- Negative exclusion: Using negative screens as part of the investment process to avoid certain companies and sectors deemed unethical; such as tobacco manufacturers, gambling businesses.
- Positive inclusion: Focusing on companies that make a positive contribution to social and environmental challenges; such as renewable energy.
- Thematic: Targeting specific ESG issues by investing in solutions that address them, such as improving gender diversity and lowering rates of hunger). Note: Some investment funds are focused on particular sectors or trends, such as financial technology funds, but may not considered within responsible investing.
- Impact: Aiming to achieve certain measurable positive outcomes, such as human rights conditions, in addition to positive investment returns.
What are ESG investments?
ESG investments are similar to traditional investments, but they take the investment decision-making process a step further. ESG investments consider the impact of ESG factors in addition to traditional financial factors when evaluating stocks or bonds as part of the investment process. An investment may exclude certain companies or industries with low ESG scores (negative exclusion), or it may include companies or industries with high ESG scores (positive inclusion) (positive inclusion). They are available in exchange traded funds (ETFs) or mutual funds, just like traditional investments.
Environmental, Social and Governance factors that affect a company’s ESG score
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| Social |
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Why should I care about ESG when I’m investing for the returns?
ESG investments enable investors to better manage risks in order to generate long-term, sustainable returns. ESG investments are similar to traditional investments in that they add a layer of portfolio analysis to identify and manage ESG-related risks that can affect both short-term and long-term investment returns. That means aiming to reduce the risk of losses while also looking for opportunities to increase returns.
According to industry and academic studies conducted by the University of Oxford, Mercer, and Morningstar (among others), ESG mutual funds and ETFs can reduce risk and provide the potential for higher long-term returns when compared to traditional mutual funds and ETFs.
What are the benefits of ESG investing?
Investors may be interested in ESG investments for a variety of reasons:
- Investing in companies with good ESG ratings can mean lower risk over time.
- Investing in companies with good ESG ratings can mean more growth over time.
- Because your kids are interested in ESG issues, and you want them to focus more on saving and investing.
- To invest in sustainable companies while meeting your financial goals.
- So that your investments reflect your values.
- To avoid companies that have a negative impact.
- To invest in companies that have a positive impact.
These benefits aren’t mutually exclusive. So while you might appreciate the impact an investment has on improving gender diversity, for example, you might decide to invest after learning that companies with gender-balanced leadership have tended to outperform those that don’t.
Is ESG investing a recent trend?
Investors have been using ESG factors to guide their decisions for decades. More recently, ESG investing began to gain significant traction when many research studies showed favorable performance for such investments and the options for ESG investing expanded.
There is more than US$35 trillion invested in sustainable assets around the world as of today, and this is expected to grow to US$50 trillion by the end of 2025 as investors seek to avoid ESG risks and find ESG opportunities.
How can I use ESG investments in my portfolio?
ESG investments give investors a range of options in terms of expected return, risk, income and diversification. You can choose to invest in just one fund or any combination, depending on your financial goals, risk tolerance and how you want to include ESG in your portfolio:
- A balanced investment option often appeals to investors looking for an easy-to-use, diversified and sustainable portfolio for retirement, college savings or other medium- or long-term goals.
- A dividend-focused option can provide potential for growth and income and is designed for long-term investment such as in a retirement portfolio or living trust.
- A global equity option can offer diversification across industries and more than 20 developed countries.
What are some key terms I should know about ESG investing?
- Active ownership: This feature of ESG investing includes two main components:
- Engagement refers to working directly with companies to support and encourage corporate policies and procedures that are likely to generate positive change in key ESG issues.
- Proxy voting uses shareholder rights to vote on shareholder proposals in support of ESG issues.
- Best in class: Approach to ESG investing based on positive inclusion rather than negative exclusion. For example, MSCI uses this approach to select companies for its Leaders Indexes that have the highest ESG ratings.
- Integration: This approach to ESG investing can be applied to any portfolio. Portfolio managers include ESG analysis as part of the overall investment decision process, as opposed to conducting ESG analysis separately.
- Negative exclusion: Funds can exclude companies on the basis of their products, policies or procedures.
- Positive inclusion: Funds can proactively select companies with positive ESG attributes, including reducing risks or seeking out ESG opportunities.
- Sustainable Development Goals (SDGs): The 17 SDGs were developed in 2015 by the United Nations and cross-industry stakeholders to provide a roadmap toward a more sustainable world. The SDGs are a framework for discussion and collaboration with companies regarding specific sustainability issues.
- UN Principles for Responsible Investing: PRI is an international organization established in 2006 to develop responsible investing. The PRI’s six core principles for responsible investing guide investors on a voluntary basis.
Now you’ve learned more about ESG investing, you can start planning to meet your financial goals in a better world. Open a BMO InvestorLine account to access all of our great online tools, research options, and educational materials. If you still need some help, get in touch with us – we’ll be happy to answer your questions.
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