The importance of ethics in investment management has long been recognized and reflected in the CFA Institute’s Code of Ethics and Standards of Professional Conduct (the Code and Standards). Historically, the emphasis of the Code and Standards has been on duties to clients and employers, priority of clients’ interests, prohibition of misuse of material non-public information, and full disclosure of conflicts of interest. 

However, the focus has widened since the 2008 global financial crisis further damaged public trust in the financial industry. Global increases in income and wealth disparity have undermined public confidence in the economic system. Expanding recognition of humanity’s role in harming the natural environment and our contribution to life-threatening climate change has alarmed the general population and scientists alike. Recently, the COVID-19 pandemic has exacerbated these concerns and shaken public confidence in the ability of countries to show solidarity when addressing global threats.

In this new environment, there has been demand for more corporate and government responsibility and a growing belief that ethics should play a greater role in many areas of economic activity, including the investing process. This has fostered the rise of environmental, social, and governance (ESG) investing. ESG investing takes explicit account of the environmental, social, and governance practices of an investment that may have a material impact on the performance of that investment. 

ESG investing identifies potential risks and opportunities beyond traditional financial analysis

While the main objective of ESG valuation remains financial performance, the integration of ESG factors enhances traditional financial analysis by identifying potential risks and opportunities beyond those considered in traditional financial analysis.

ESG investing commonly considers a range of factors. Environmental factors typically include the type and extent of energy consumption, pollution generated, and efforts made to preserve natural resources and wildlife. Social factors include human rights, health and safety, and shareholder, employee, and other stakeholder relations. Governance factors include board independence, quality and compensation of management, disclosure practices, and shareholder rights. 

Investments with good ESG scores have the potential to enhance returns, while those with poor ESG scores may inhibit returns. Although ESG fund managers are capitalists investing to make money, they consider ESG factors to achieve better risk–reward ratios in their investments, providing another example of how building trust and good ethics can actually enhance economic returns rather than detracting from them. 

It is important to distinguish ESG investing from other investing styles: 

1) Socially responsible investing (SRI) goes further than ESG investing by actively eliminating or selecting investments according to specific ethical guidelines that may be based on religion, personal values, or political beliefs. Unlike ESG analysis, which is reflected in valuations, SRI uses ESG factors to apply negative or positive screens to prospective investments. 

2) Impact or thematic investing selects investments to have a positive effect on a business or organization and seeks to achieve certain goals that are beneficial to society or the environment. An example would be investing in a non-profit enterprise dedicated to the development of clean energy, regardless of whether business success is very likely.

ESG metrics are not commonly included in mandatory financial reporting, although companies are increasingly making disclosures in their annual reports and standalone sustainability reports. Several institutions, such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD), are working to set standards and define materiality to facilitate the incorporation of ESG factors into the investment process.

CFA Institute is setting standards to mainstream ESG investing 

CFA Institute has been a driving force in environmental, social, and governance factors in financial analysis for many years. ESG analysis has become an increasingly important part of the investment process as investors study ESG data to gain a fuller understanding of the companies in which they invest.

As ESG investing accelerates, key issues are emerging—notably climate change, social unrest, and the COVID-19 pandemic—that are intensifying discussions about the interconnectedness of sustainability and
the financial system. 

CFA Institute is leading the financial industry by producing valuable research, convening experts and practitioners for discussion, and setting standards to enable the mainstreaming of ESG investing.

ESG factors are often interconnected, and it can be challenging to classify an issue under individual ESG classifications. ESG factors can often be measured (e.g., employee turnover at a company, the number of independent board members), but it can be difficult to assign them a monetary value. There is no standardized approach for the calculation or presentation of various ESG metrics. Investors can employ a range of analytical approaches and data sources to address ESG considerations, including weighting them based on client interest and potential value. Understanding the relative merits and limitations of different metrics can help to form a more complete picture of ESG risks and opportunities.

CFA Institute believes more thorough consideration of ESG factors by financial professionals can improve the fundamental analysis they undertake and, ultimately, the investment choices they make. Accordingly, CFA Institute continuously monitors key debates and evolving issues in the investment industry. Investment professionals globally have increasing interest in ESG investing and analysis as governments, asset owners, and high-net-worth investors consider the impact of ESG factors on their investments and local markets. 

CFA Institute’s initiative will help to ward off greenwashing

CFA Institute is specifically focused on the quality and comparability of the ESG information provided by corporate issuers and on how to integrate various ESG factors into the investment selection process. In this regard, CFA Institute has published its ESG Disclosure Standards for Investment Products, which provides a framework for investment managers to better communicate and their clients to better understand the nature and characteristics of ESG-focused funds and investment strategies. 

With the proliferation of investment products in this field and the risk of greenwashing for marketing purposes, CFA Institute’s leadership in this area is both timely and necessary. 

Getting a head start on ESG

In March 2021, CFA Institute launched a Certificate in ESG Investing that offers practical applications and technical knowledge of ESG investing. Like the CFA program itself, the certificate and learning materials were developed by leading practitioners for practitioners. The program has been recognized by the Principles for Responsible Investment (PRI), a United Nations-supported independent body that seeks to encourage investors to use responsible investment to enhance returns and better manage business risks. The certificate program is owned and administered by CFA Institute. 

For practicing investment professionals, the course provides an opportunity to accelerate their progress in this growing field and demonstrate their commitment to ESG standards. Meanwhile, the groundbreaking Standards represent a new intersection of ethics and financial analysis and are likely to continue to command ever-growing attention from both investment professionals and their clients. 

*The Standards can be accessed in full here