Many investors want their money to do some good, or at least no harm. Here’s what ESG investing actually means, how funds decide what to include, and why regulators are cracking down on greenwashing.
ESG investing considers environmental, social and governance factors when choosing investments.
Environmental factors include a company’s greenhouse gas emissions, pollution, water use and impact on nature.
Social factors include how it treats workers, customers, suppliers and communities, such as labour practices, safety and human rights.
Governance factors cover how a company is run, including board independence, executive pay, transparency and shareholder rights.
Different approaches
Not all ESG or ethical funds work the same way.
Some use negative screening, excluding industries such as tobacco, weapons, gambling, or fossil fuels.
Others use positive screening, choosing companies they believe perform best on ESG measures within their industry.
Impact investing aims to achieve measurable social or environmental outcomes, such as funding renewable energy or affordable housing, alongside financial returns.
Some investors use engagement, buying shares in companies so they can push them to improve through voting at meetings and talking with boards.
Because approaches differ, two funds labelled “sustainable” can hold very different investments.
Ratings
Specialist research firms produce ESG ratings for companies. But ratings from different firms often disagree, because they weigh different factors and use different data.
Greenwashing
Greenwashing is when a company or fund makes misleading claims about how environmentally friendly or ethical it is.
The Australian Securities and Investments Commission has taken action against several investment managers and super funds for greenwashing, including funds that claimed to exclude certain industries while holding investments in them. Courts have ordered penalties of millions of dollars, including against Vanguard Investments Australia and Mercer.
The Australian Competition and Consumer Commission has also targeted misleading environmental claims by businesses.
Climate reporting
From 2025, Australia began phasing in mandatory climate-related financial reporting. Large companies must now report on climate risks and their emissions in their annual reports, with smaller companies following in later years.
The aim is to give investors consistent, reliable information to compare companies.
The debate
Supporters argue ESG factors help identify risks that traditional financial analysis can miss, such as climate change, and that well-run companies tend to perform better over the long term.
Critics argue ESG can be vague and inconsistent, and that investors should focus solely on returns. In the U.S., ESG has become politically controversial, with some Republican-led states restricting its use by public funds.
Research on whether ESG funds perform better or worse than other funds is mixed, and often depends on the period studied, such as how oil and gas companies performed.
