Introduction to ESG
ESG investing uses environmental, social, and governance factors alongside traditional financial analysis. Candidates must distinguish related but non-identical terms: socially responsible investing (SRI) historically relied on values-based exclusions; ESG integration embeds material factors into security analysis and valuation; impact investing targets measurable, additional positive outcomes; sustainable investing is the broad umbrella. A key idea is materiality: an ESG factor matters only if it can affect cash flows, risk, or enterprise value, and materiality is industry-specific.
Traps: questions often test whether a practice is values-based or value-based; ESG is not a single score or a moral checklist. Another trap is assuming engagement and exclusion are interchangeable. Know the arc of the field: early religious and ethical exclusions, 1970s civil-rights and environmental screens, the 2006 UN PRI, the 2015 Paris Agreement and SDGs, and the shift toward regulation and disclosure.
Rule of thumb: ask three questions for any ESG claim - Is the factor material to this business? Is it already priced? What is the investor's stated objective (values, risk, or impact)?
Worked example: an investor who excludes tobacco for ethical reasons is doing values-based screening; an analyst who raises the discount rate for a utility with high transition risk because higher-cost capital is likely is doing financial integration. Both are sustainable investing, but only the second is a valuation adjustment.