How selfish soever a man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others, and render their happiness necessary to him, though he derive nothing from it except the pleasure of seeing it.
For the past 200 years Adam Smith has been celebrated as the father of modern capitalism and his magnum opus, "The Wealth of Nations," is considered to be the authoritative work on free market economics and maximization of profits. However, the quote in the beginning of this paragraph is taken from the opening of Smith's less famous work, yet one he considered more important, "The Theory of Moral Sentiments." It is certain that the grandfather of capitalism pondered the importance of factors other than profits and their value in creating overall happiness for the individual.
In the past century there were few if any factors that people considered when investing other than corporate profits. In fact, many investors were happy to put their money behind a CEO who personified Scrooge from Charles Dickens', "A Christmas Carol" because conventional wisdom was that companies run by those types of individuals would net bigger profits. A company's impact on the environment was of little concern, and conditions in the workplace were irrelevant as long as workers were productive and efficient. And of course, there was no Al Gore telling us that the ocean will cover the continents unless we stop burning oil, he was still busy inventing the internet.
Fast forward to today and capitalism isn't what it used to be. We can call it Capitalism 2.0. Many investors, by some estimates over 35% and growing, care about the Environmental, Social and Corporate Governance (ESG) factors of their portfolio companies. Others won't invest into companies that do business with counties whose government policies they oppose. Many institutions and endowments are simply prohibited from investing into securities of companies that have not met a certain ESG criteria. All of this translates into capital shifting from companies with meager ESG performance to companies that consider ESG a top priority of their business.
The misconception among some people is that ESG analysis aims to replace companies from one industry with "green" companies from a different industry, and in most cases this is not true. For example, no one would disagree that oil companies are generally not great for the environment and perhaps some investors don't want anything to do with the oil industry, but, those investors who do want to invest into energy and also are ESG conscious don't necessarily need to swap out of oil companies and into solar stocks. They have the choice of investing into HES, which has one of the best environmental records among big oil companies and avoid XOM and BP, which are two of the worst. Investors that are concerned with social and corporate issues don't automatically need to run from WMT to WFM but can stay in the retail sector and still be within their ESG comfort zone by investing into COST.
Of course, the purpose of ESG analysis is not just to enable us to invest within our moral brackets but it is rooted in strategic risk management. Companies with low ESG scores across an array of issues have elevated exposure to costly lawsuits, regulatory interventions, consumer backlash, and labor disputes, all of which can cause major and swift declines in stock price. It should then come as no surprise that ESG analysis is one of the fastest growing areas of research among asset management firms, which are rapidly upgrading their investment methodology to reflect Capitalism 2.0