ESG investing is an approach that considers environmental, social, and governance (ESG) factors. These factors can impact a company’s financial performance and, as such, are material considerations for investors.
The Securities and Exchange Commission (SEC) has been paying increased attention to ESG investing, and in May 2022, the SEC released new guidance on the disclosure of ESG information. The guidance clarifies that the SEC expects companies to provide detailed information about their operations in prospectuses, annual reports, and advisor brochures. The proposal segments ESG investment strategies into integrated, focused, and Impact ESG funds.
This blog post will explain how a fund falls into the three SEC’s ESG integration category.
SEC’s ESG Integration Category: The Three Types Of ESG Funds
1. ESG Integration Funds
The United States Securities and Exchange Commission defines ESG integration as “an investment strategy that considers an environmental, social or corporate governance factor alongside other factors in decision-making.”
ESG stands for Environmental, Social, and Governance. It is a framework that allows investors to understand how companies deal with ESG issues like climate change or employee relations. “Integration” is the extent to which an investor applies environmental, social, and governance standards in constructing their investment portfolio.
An investment strategy considering ESG factors can be deemed to have an Integration objective. An ESG Integration fund does not have to consider or exclude all companies based on their environmental, social, and governance records. These factors are one way an ESG integration manager might decide how to deploy investor capital.
If making an environmentally conscious investment might not be good for the bottom line, this fund may refuse to play that game.
2. ESG-Focused Funds
The SEC defines “ESG-Focused Funds” as funds that consider environmental, social, and governance issues in investment decisions. The funds include, for example, those that apply exclusionary or inclusionary screens, engage with issuers to understand their outlooks and how they address key ESG issues (e.g., climate change), and track indexes that consider ESG factors when forming portfolios. The category also includes any fund that markets itself as having environmental sustainability at its core.
3. ESG Impact Investing
Impact investing is investing to generate both financial returns and positive social or environmental impact. Impact investing is the most demanding of all the potential ESG strategies; it is typically considered a superior form of finance-driven impact because it seeks not only to mitigate environmental and social problems but also (as its name suggests) drive an “impact” on society through positive change. Companies following this strategy are also committed to reporting their results so you can see if they’re making any positive changes.
Summary
The SEC’s ESG integration category provides a framework for investment managers to incorporate environmental, social, and governance (ESG) principles into their analysis. This definition helps investors make more informed decisions when looking at different options. Also, the SEC requires that fund companies provide investors with more detailed information on their prospectuses, annual reports, and advisor brochures. These will allow investors to see how companies manage their exposure to climate change, human rights governance, and other societal issues.
