When you invest in a company, do its financial results have to be the only thing that matters? For some investors, the answer is NO. They may also want to know how a company treats its employees, what impact it has on the environment, whether its management is transparent or whether its business practices are consistent with their personal values.
This is what we call ESG.
ESG stands for Environmental, Social and Governance – three groups of factors that can be used to evaluate companies and investments beyond traditional financial metrics. They can help investors identify additional risks, compare companies and decide which businesses or sectors they do – or do not – want in their portfolios.
Importantly, ESG does not provide a universal definition of what is “ethical”. Different investors may have different priorities and values. Instead, ESG offers a structured way of examining issues that may otherwise be difficult to incorporate into an investment decision.
From ethical investing to ESG
The idea of considering values when investing is older than the term ESG itself. Modern socially responsible investing, or SRI, gained prominence in the 1960s and 1970s. One of its most notable examples was the campaign against apartheid in South Africa. During the 1970s and 1980s, some investors and institutions sought to divest from companies with links to the apartheid regime.
Over time, the idea evolved from simply excluding particular companies or industries towards analysing a broader range of environmental, social and governance factors. The term ESG – Environmental, Social and Governance – became established in the financial world in the early 2000s, notably through the 2004 Who Cares Wins initiative.
The basic question behind it, however, remains familiar: should investors consider how a company operates and not only how much money it makes?
Recent events show how such considerations can influence attitudes towards companies. After Russia invaded Ukraine in 2022, businesses faced pressure from investors, customers and the public over whether they would continue operating in Russia. According to research maintained by the Yale School of Management, more than 1,000 companies publicly announced that they were curtailing their Russian operations beyond the minimum required by sanctions.
Environmental issues have also become increasingly visible – from the carbon footprint of manufacturing and renewable energy use to packaging and the sustainability of supply chains.
ESG – as mentioned above – attempts to organise questions like these into three broad categories.
E – Environmental
The Environmental part of ESG concerns a company’s impact on the natural environment and the environmental risks it faces. Investors may consider greenhouse gas emissions, energy and water consumption, waste, pollution or the impact of a company’s activities on ecosystems.
For example, a manufacturer may reduce emissions by improving production processes, switching to renewable energy or investing in lower-emission technologies. Another company might redesign its products or packaging to reduce waste and raw-material consumption.
For an investor, this can help answer questions such as:
How exposed is the business to environmental or climate-related risks – and what is it doing to manage them?
S – Social
The Social pillar looks at how a company interacts with people – including employees, customers, suppliers and local communities. This may include working conditions, employee health and safety, human rights, diversity, labour standards in supply chains, data protection and product safety.
Investors might examine whether a company provides safe working conditions, respects employee rights or has systems to prevent forced or child labour in its supply chain. They may also consider how it treats customers and protects their personal data.
G – Governance
The Governance pillar concerns how a company is managed and controlled. It can include board independence, executive remuneration, shareholder rights, accounting practices, business ethics, anti-corruption policies, conflicts of interest and transparency.
Transparent accounting, independent oversight and clear rules for avoiding conflicts of interest can reduce certain risks. Weak governance, on the other hand, may increase the probability of scandals, fraud, regulatory problems or decisions that favour management over shareholders.
How can investors use ESG?
ESG does not have to replace traditional financial analysis. Instead, it can provide investors with an additional layer of information. An investor analysing a company might examine its revenue growth, profitability, debt and valuation – and then look at ESG factors that could affect its long-term prospects.
For example, high emissions could create additional costs if environmental regulations become stricter. Poor working conditions could lead to employee turnover, strikes or reputational damage. Weak corporate governance could increase the risk of fraud or poor capital allocation.
ESG can also be used as a screening tool. An investor might decide to exclude certain industries or companies that do not meet specific criteria.
Another approach is “best-in-class” selection, in which investors look for companies with stronger ESG profiles relative to other businesses in the same industry.
ESG analysis can therefore serve several purposes:
- identifying additional risks,
- comparing companies,
- screening investments
- or building portfolios according to specific sustainability criteria.
ESG ratings – can responsibility be measured?
So how do investors actually measure ESG? One tool is an ESG rating.
Specialised providers analyse corporate data and assign companies ESG scores or ratings. However, there is no single universal system. Providers use different methodologies, indicators and weightings, so the same company can receive different assessments. An ESG rating should therefore be treated as one analytical tool rather than a definitive verdict on whether a company is “good” or “bad”.
Some of the best-known systems include:
MSCI ESG Ratings – MSCI rates companies from AAA to CCC, assessing how well they manage financially relevant sustainability risks and opportunities relative to industry peers. MSCI reports coverage of more than 17,000 issuers and around 999,000 securities worldwide.
Morningstar Sustainalytics ESG Risk Ratings – measures a company’s exposure to material ESG risks and how effectively these risks are managed. Companies are grouped into five risk categories, from negligible to severe. Sustainalytics reports coverage of more than 16,000 companies.
S&P Global ESG Score – uses the Corporate Sustainability Assessment and other data to evaluate companies across environmental, social and governance topics. S&P Global reports ESG data coverage of approximately 13,000 companies.
CDP (Carbon Disclosure Project) – focuses primarily on environmental disclosure, including climate change, water security and forests. In 2024, more than 24,800 companies disclosed environmental data through CDP.
ESG ETFs and indices – can you invest according to your values?
Investors do not necessarily have to select individual companies themselves. There are also ETFs based on ESG or sustainability criteria.
ESG indices are another way of applying these criteria to the financial markets: they typically select, exclude or weight companies according to specific environmental, social and governance rules.
ETFs may then track such indices, giving investors exposure to a portfolio constructed according to these criteria. They may also focus on specific sustainability themes.
However, an “ESG ETF” does not mean that every company it holds will meet every investor’s personal definition of an ethical business. The portfolio depends on the methodology and criteria used by the fund or its underlying index. Investors should therefore look beyond the ESG label and examine the fund’s methodology, exclusions, holdings and investment objective.
Regulators have also responded to concerns about potentially misleading sustainability claims. Under ESMA guidelines introduced in 2024, funds using ESG- or sustainability-related terms in their names generally need at least 80% of their investments to meet the environmental or social characteristics or sustainable investment objectives associated with their strategy.
ESG investing today
Sustainable investing has developed into a significant part of the investment market. According to Morningstar, assets in global sustainable open-end funds and ETFs exceeded USD 3.9 trillion at the end of 2025.
However, growth is not guaranteed. Global sustainable funds recorded approximately USD 84 billion in net outflows in 2025, following USD 38 billion of inflows in 2024. It was the first year of annual global redemptions since Morningstar began tracking the segment in 2018.
What are the risks of ESG investing?
Using ESG criteria does not eliminate investment risk. ESG-oriented strategies also have challenges of their own:
No single ESG standard
There is no universal methodology for ESG ratings. Different providers use different data, criteria and weightings, meaning the same company may receive very different scores.
Greenwashing
Companies or investment products may present themselves as more sustainable than they actually are. An ESG, “green” or “sustainable” label alone does not tell an investor exactly what a fund owns or how strict its criteria are.
Regulatory risk
ESG regulations continue to evolve, particularly in Europe and the United States. New definitions, disclosure requirements or fund rules can affect companies and investment products.
Higher analytical complexity
Assessing ESG factors requires additional data and analysis. Information may also be incomplete or difficult to compare between companies, making investment analysis more complex.
Concentration and diversification risk
Excluding companies or entire industries on ESG grounds can reduce diversification or create greater exposure to particular sectors.
ESG ratings can change
Ratings may change because of new information, changing law, corporate controversies or changes to a provider’s methodology. Investors should therefore understand not only a company’s score, but also what it measures and how it is calculated.
ESG does not guarantee better returns
A high ESG rating does not automatically make a company a good investment. Prices are still influenced by earnings, valuations, interest rates, economic conditions and many other factors. ESG can add information to an investment analysis, but it cannot eliminate market risk or guarantee positive returns.
So, can investing be ethical?
It can certainly be more aligned with an investor’s values. ESG gives investors tools to ask questions that traditional financial ratios alone may not answer: How does this company affect the environment? How does it treat people? How is it governed? What sustainability-related risks could affect its business in the future?
Ratings, ESG indices and ESG-focused ETFs have made it easier to incorporate these considerations into investment decisions. But there is no universal ESG score that can decide whether an investment is ethical on an investor’s behalf.
Ultimately, ESG is best understood as an additional framework for analysis. It can help investors look beyond financial statements, identify risks that might otherwise be overlooked and choose investments that more closely reflect their priorities.
And that is perhaps the most important idea behind responsible investing: knowing not only what you are investing in, but also understanding how the businesses behind your investments actually operate.
FAQ
What is ESG?
ESG stands for Environmental, Social and Governance. It is a framework used to assess companies and investments based on environmental impact, relationships with employees, customers and communities or corporate governance practices. ESG factors can complement traditional financial analysis by providing additional information about potential risks and opportunities.
How can investors evaluate companies using ESG criteria?
Investors can analyse environmental, social and governance factors themselves or use ESG ratings provided by organisations such as MSCI, Morningstar Sustainalytics, S&P Global and CDP. Since providers use different methodologies, the same company may receive different ESG assessments, so ratings should be treated as one of several analytical tools.
How can you invest according to ESG criteria?
Apart from selecting individual companies, investors can use ETFs that follow ESG-focused indices or sustainability strategies. Such indices may select, exclude or weight companies according to specific ESG criteria. Investors should always check the methodology, exclusions and holdings of a particular fund rather than relying on the ESG label alone.
Are ESG investments safe?
ESG criteria do not make an investment inherently safer or guarantee positive returns. ESG investing involves the usual risks associated with financial markets as well as specific challenges such as inconsistent rating methodologies, greenwashing, changing regulations and potentially lower portfolio diversification. Investors should therefore consider both financial and ESG-related risks before making an investment decision.