Environmental, Social, and Governance (ESG) investments remain prominent for investors looking to align their portfolio with their values. At the same time, the investment industry continues to evolve its evaluation of ESGs as companies work to determine their risks and make transition plans for sustainable practices.
With recent regulatory developments from the Securities and Exchange Commission (SEC) occurring, we consider how they will affect investment analysis of ESGs. The new SEC requirements for transparency in data and disclosure should help with gaining insight into companies’ environmental reporting.
This is a three-part series that will explain how ESG policies can strengthen investment analysis. In this first article, we discuss the role of environmental evaluation.
ESG analysis
We know that extreme weather events are on the rise.1 In 2023 alone, the U.S. experienced over $90 billion in costs occurred from climate disasters.2 Be it floods, tornados, hurricanes, or drought, there is substantial impact to businesses operating across the states. There are certain industries that are more susceptible to extreme weather events. Location can also be an important factor when determining climate risk. Companies that are prepared to protect their real estate, assets, and operations in higher risk areas may hold up better than their peers. A company’s ability to, quite literally, weather storms and suffer less loss could translate to more value for shareholders.
ESG analysis is based on scores a company receives from an outside entity in these three distinct areas of concern: environmental, social, and governance. Depending on the industry, the scores in one, two, or all three of these categories may reveal significant risks or opportunities for a company’s future. ESG scores offer investors insight into those risks and how a given company is addressing them in comparison to its peers.
As we think about investment analysis and explore the “E” in ESG, we can think of scoring as an additional data point when evaluating securities. With recently added regulations from the SEC, due to investor demands, more companies than ever will likely be making meaningful greenhouse gas emission reduction commitments and analyzing potential business risk posed from climate threats.
Recent regulatory advancements
ESG analysis can assess a company’s readiness to meet new regulatory requirements. In early 2024, the SEC ruled to standardize climate-related disclosures. Due to increasing investor demand for transparency and consistency in data reporting, the SEC responded by enhancing an already-existing rule that applies to public companies. Companies are required to disclose data related to their potential climate risks, efforts made to mitigate risks, stated targets to reduce risks, estimates and assumptions used in calculating these risks, and the costs associated.3 In short, progress is being made to better assess climate-related data and determine a company’s environmental impact, thereby helping investors better evaluate their ESG investment options.
Examples of environmental impacts
The “E” in ESG investments relates to the measurement of a company’s impact on the environment(s) in which it operates. In addition to greenhouse gas emissions, analysts look at resource depletion, pollution, water usage, and waste management.
The Great Lakes, accounting for the vast majority of North America’s fresh water source, suffered from decades of industrial waste dumping. It wasn’t until 1970 when President Nixon created the Environmental Protection Agency (EPA) that we began to see industries held accountable for their effects on the environment. This is an extreme example of environmental negligence but shows how regulatory risk can impact a company’s operations.
Another example of regulatory advancement, this time for the betterment of air quality, was when George H.W. Bush strengthened the Clean Air Act in 1990, setting standards for emissions of hazardous pollutants. This certainly caused an effect down the supply chain of companies producing, purchasing, and utilizing the emitters that are now banned, and created an opportunity for less harmful alternatives.
Energy companies tend to be the biggest emitters of air pollution. However, there have been significant advancements in the areas of carbon intensity, methane management, and net-zero emissions goals.
Companies working to mitigate environmental, technological, and regulatory risks will score far better in the “E” of ESG analysis. If they are unable to pivot when regulatory requirements change, they may also be hindering their ability to deliver positive returns for shareholders.
What this means for investors
The common goal amongst investors is earning positive returns. Long-term investors should expect their portfolio to outpace inflation, compound overtime, and sustain cash flow needs throughout their lives. It’s important to know whether companies are prepared for changes in the environmental landscape — whether regulatory, technological, or climate-driven — because they will likely have a better ability to maintain positive investment returns. ESG analysis can provide investors with insight into adding ESG investments to their portfolio so that it is more aligned with their goal for returns.
If you are a Mercer Advisors client, reach out to your wealth advisor to discuss our wide variety of customizable ESG options. If you are not a client and have questions about ESG investments, let’s talk.
To learn more about ESG investing, we encourage you to read the other two articles in this series:
1“Extreme Weather and Climate Change” March 20, 2024.
2“Billion Dollar Weather and Climate Disasters” March 28, 2024.
3“SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors”
