What is ESG or sustainable investing? ESG analysis or sustainable analysis is an increasingly important part of investment decision-making. But what does it actually mean? Well, the E, S, and G stand for environmental, social, and governance. So ESG analysis is therefore about including environmental, social, and governance risks into the analysis. So let's drill into this a bit further. Firstly, environmental risks. These are the risks that the company could negatively affect the environment in some way. Now, typically the main focus here is concerns around climate change as a result of greenhouse gas emissions. However, it also includes risks around the use of limited natural resources such as agricultural land and water. But it also includes pollution and waste risks and that would include things like the production of hazardous waste, which could impact on biodiversity or the risk that large amounts of physical waste can be harmful to society or animals. Note that the risks around pollution and waste include waste produced during manufacturing but also that produced at the end of the product life cycle, so for example, on disposal of the product. Now let's look at social risks. And these are the risks that company or its operations could negatively affect people in some way. This can either be the employees of the company, and that's referred to as human capital or the customers and wider public, and that's sometimes referred to as social capital. Examples of social capital risks are things like product safety and data security. Now let's look at governance risks, and these are the risks that the company and its operations are not managed in an effective and ethical way. Typically, analysis of governance risks focuses on the ethics of the business, so compliance with rules and regulations, as well as the quality of management and its decision-making, and that's referred to as corporate governance. ESG analysis requires investors to decide which risks are likely to be significant to a company's future performance and incorporate this into the investment decision-making in some way. So how's this done? Well, let's start off with traditional investment analysis. This involves combining quantitative analysis, such as looking at historic financials and qualitative analysis, so for example, thinking about the company's strategy and then forecasting the company's earnings and cash flows using this analysis. This allows investors to estimate the value of the company. Once they've done this, they can compare their valuation to the current market value to decide whether to invest or not. In theory, if the investor's valuation is higher than the market value, they should invest. Whereas if the investor's value is lower, then they should not invest or sell the stock if they already own it. So where does ESG come into this? Well, ESG integration is really about extending the scope of risks and opportunities which the investors consider in their analysis. So in addition to thinking about, say, the risks around market competition or customer demand or even operating costs, the investor would also think about how climate change, labor practices, or business ethics impact on their forecasts and valuation. In theory, if these are material risks, then they should lead to superior investment decisions because the valuation now includes all material risks, so the investor has superior information on risk-adjusted returns.