adaptation-finance – Chasing Tales

First, a list of definitions:

Asset: Any resource of economic value owned or controlled by an individual or entity, expected to provide future financial benefit.
Asset Class: Broad categories of assets that behave similarly, e.g., equities (stocks), fixed income (bonds), cash, real estate.
Asset Type: Specific forms within an asset class, e.g., large cap, small cap stocks within equity.
Portfolio: A collection of investments held by an individual or entity.
Portfolio Weight: The percentage each asset contributes to the total value of a portfolio.
Asset Allocation: The strategy for distributing investments among different asset classes for balancing risk and return.
Diversification: Investing in different assets to reduce overall portfolio risk.
Rebalancing: Adjusting asset proportions in a portfolio to maintain target allocation that had been decided at the time of deciding asset allocation.
Liquidity: How easily an asset can be converted to cash without affecting its price.
Risk: The chance an investment might lose money or underperform expectations.
Risk Tolerance: Willingness or ability to withstand investment losses or volatility.
Volatility: The degree and frequency of changes in prices of an asset.
Portfolio Risk: The uncertainty of the entire basket of investments losing value or performing below expectations.
Market Risk/ Systematic Risk: Risk due to economy-wide factors affecting all investments.
Credit Risk: Risk that bond issuers or borrowers may default.
Company-specific Risk/ Unsystematic Risk: Risk tied to individual companies or securities.
Downside Risk: The potential for an investment to lose value due to negative market conditions. This focuses only on the probability and quantity of losses rather than the probability of volatility of prices. ESG investing primarily provides downside protection rather than return enhancement.
Volatility: The degree of price fluctuation in either direction in an asset or portfolio over time.
Benchmark: A standard (often an index) for comparing investment performance (e.g., Nifty 50).
Tracking Error: The difference between a portfolio’s returns and the returns of the benchmark its tracking.
Capital Gain: Profit made from selling an asset for more than it’s cost.
Dividend: Payments made by companies to shareholders, usually from profits.
Compound Interest: Earning interest on initial investment plus prior earned interest—critical for long-term growth.
Net Asset Value (NAV): Value per share of mutual funds or ETFs, calculated as total assets minus liabilities divided by shares.
Bull Market / Bear Market: Extended period of rising (bull) or falling (bear) asset prices.
Yield/ Return: Income return on investments, such as interest or dividends.
Turnover: The rate at which securities are bought/sold in a portfolio; high turnover can mean higher costs.
Sharpe Ratio: Measures risk-adjusted return, penalising for volatility.
Portfolio Optimisation: Selecting the best mix of assets to maximise returns for a given risk.
Passive/Active Management: Passive strategies track a benchmark, active invest based on analysis, not constrained to an index.
Index: A selection of securities representing a market or sector, used for performance tracking and benchmarking.
Index Risk Characteristics: How much an index’s value fluctuates due to its components; calculated via weighted average of the securities’ price changes.
Portfolio Tilting: Adjusting portfolio weights to emphasise preferred features (like ESG leaders) while maintaining diversification.
ESG Ratings/Scores: Independent evaluations of companies’ ESG performance.
Materiality: How significantly issues affect a company’s business or financial outcomes.
Greenwashing: Misleading claims of sustainability or ESG compliance by firms, especially the G part.
Greenhushing: Deliberately under-reporting or not reporting genuine environmental action.
Stakeholder: All groups affected by company actions, such as shareholders, employees, customers, suppliers, communities.

Now onto ESG investing.

What
ESG investing is a way to put money into companies while considering more than just their financial returns. The non financial factors considered are Environmental, Social, and Governance (ESG) aspects of the company.

Here’s a list of ESG laws in India.

A small list of different ESG aspects:

Environmental Factors	Social Factors	Governance Factors
Resource use, pollution, waste creation, waste disposal, sustainable procurement, biodiversity impacts,	Human rights, equality, equity, diversity, inclusion, human capital management, customer safety, customer satisfaction,	Corporate governance, executive compensation, board membership, whistleblower protection, corporate transparency, business ethics, shareholder compensation and rights, stakeholder engagement

Why
ESG investing has evolved from a niche ethical consideration to a fundamental component of modern investment strategy due to the recognition that environmental, social, and governance factors pose material financial risks that can devastate companies when left unmanaged. The core imperative for ESG investing lies not in altruism but in financial reality: companies that fail to manage ESG risks face losses that can destroy shareholder value and damage their competitive position.

Mismanaged environmental risks can result in extensive fines, settlements and other costs, stock price collapse, CEO resignations, criminal investigations, and business model restructuring.

Examples:
The Volkswagen emissions scandal: the company was charged over $30 billion in fines, settlements, and other costs after installing “defeat devices” in 11 million diesel vehicles to cheat on emissions tests.¹ The misconduct triggered an immediate stock price collapse, forced resignations, sparked criminal investigations across multiple continents, and required the company to fundamentally restructure its entire business model toward electric vehicles.

The BP Deepwater Horizon oil spill resulted in $20.8 billion in environmental damage settlements, the largest in U.S. history, plus additional billions in cleanup costs, lost revenues, and operational disruptions.² ³ The environmental damages translated directly into financial losses through fishing industry shutdowns, tourism declines, and permanent ecosystem service losses valued at $17.2 billion.⁴

Here’s an explanation of ecosystem services.

Social risks create equally devastating financial consequences when companies fail to maintain proper governance over workplace culture and employee treatment.

Examples:
The Wells Fargo cross-selling scandal, where employees created 3.5 million fraudulent accounts without customer consent, resulted in $3.7 billion in settlements and fundamentally shattered the bank’s reputation for customer-centric service.⁵ The scandal emerged from toxic sales cultures that imposed impossible quotas on employees, leading to widespread fraud, customer harm, and eventual regulatory intervention.

In 2025, Google agreed to pay $50 million to settle a lawsuit alleging bias against Black employees.⁶ Simultaneously, the company paid an additional $28 million to settle claims that it favored white and Asian employees.⁷ Adding to Google’s social risk exposure, the company faced a separate $118 million gender discrimination settlement involving approximately 15,500 employees.⁸ These combined settlements totaling $196 million (50+28+118) reflect systematic failures in Google’s workplace culture and diversity management that created material financial liabilities.

While risk management drives the primary rationale for ESG investing, additional business benefits strengthen the investment case. Better risk management reduces costly scandals and regulatory penalties, improved stakeholder relationships enhance operational resilience, and ESG practices often drive operational efficiencies that reduce costs.

Investor demand increasingly favors ESG-compliant companies, with over 90% of younger investors showing interest in sustainable investing.⁹ ESG-focused institutional investments are projected to reach $33.9 trillion by 2026,¹⁰ while 89% of investors consider ESG when making investment decisions¹¹. This demand translates into better access to capital and lower financing costs for companies with strong ESG credentials.

Regulatory momentum makes ESG compliance increasingly mandatory rather than voluntary. The European Union’s Corporate Sustainability Reporting Directive, India’s Business Responsibility and Sustainability Report framework, and similar regulations worldwide require comprehensive ESG disclosures and accountability. Companies failing to meet these requirements face market access restrictions, regulatory penalties, and competitive disadvantages.

Research demonstrates that ESG investing provides downside protection, especially during social or economic crises.¹² During the COVID-19 pandemic, companies with robust ESG practices demonstrated greater financial resilience and risk management capabilities compared to conventional peers.¹² This downside protection stems from ESG companies’ superior risk management, stakeholder relationships, and operational flexibility.

Climate-related weather events are expected to cost suppliers $1.3 trillion by 2026.¹³ Companies with strong environmental practices position themselves to avoid these costs through improved resilience, supply chain diversification, and proactive adaptation measures. This represents massive potential savings compared to companies that ignore environmental risks.

How
ESG investment strategies provide multiple pathways for investors to align their portfolios with environmental, social, and governance principles while pursuing financial returns. Understanding these distinct approaches enables investors to select methods that best match their values, risk tolerance, and impact objectives.

Negative Screening (Exclusionary Screening)
Negative screening represents the oldest and most straightforward ESG approach, systematically excluding companies or entire sectors that fail to meet specific ethical or sustainability criteria. This strategy originated in the 1970s with religious investors avoiding industries like tobacco, alcohol, gambling, and weapons manufacturing.¹⁴ ¹⁵

Modern negative screening has expanded significantly beyond traditional “sin stocks” to exclude companies with poor environmental records, human rights violations, or severe governance failures. For example, many European pension funds exclude companies involved in coal mining or controversial weapons, while Norway’s Government Pension Fund Global eliminates companies with severe environmental damage or human rights violations from its portfolio.

The screening criteria can range from broad sector exclusions to specific revenue thresholds, such as excluding companies that derive more than 10% of revenue from fossil fuel extraction. This approach allows investors to avoid supporting business activities that conflict with their values while maintaining diversification across other sectors.

Positive Screening (Best-in-Class Selection)
Positive screening takes the opposite approach by actively seeking companies that demonstrate superior ESG performance within their respective industries. This “best-in-class” methodology allows investors to maintain sector exposure while favoring companies with the strongest sustainability credentials.

Unlike negative screening, positive screening doesn’t automatically exclude controversial sectors like oil and gas or mining. Instead, it identifies companies within these industries that show the best ESG practices, commitment to improvement, and transition strategies. For instance, an oil company might qualify if it demonstrates the lowest carbon intensity, strongest safety record, and most credible renewable energy transition plan in its peer group.

BlackRock, the world’s largest asset manager, exemplifies this approach by selecting companies with the highest ESG ratings in each sector for its ESG-focused funds. The Dow Jones Sustainability Indices follow similar principles, annually selecting the top 10% of companies in each sector based on ESG criteria.¹⁶

ESG Integration
ESG integration systematically incorporates environmental, social, and governance factors into traditional investment analysis alongside financial metrics. Rather than simply screening companies in or out, this strategy uses ESG data to better understand risks, opportunities, and long-term value creation potential.

This approach recognises that ESG factors can significantly impact a company’s financial performance, competitive position, and operational resilience. Investment analysts examine how climate risks might affect a utility company’s infrastructure costs, how labor relations impact a retailer’s operational efficiency, or how board composition influences strategic decision-making quality.

Unilever demonstrates ESG integration through its Sustainable Living Plan, which focuses on environmental impact, social responsibility, and governance to reduce risk, build stakeholder trust, and deliver consistent financial performance.

Thematic Investing
Thematic investing focuses on specific ESG themes or sectors that address major global challenges while offering growth opportunities. This strategy identifies long-term sustainable trends and invests in companies positioned to benefit from these developments.

Common thematic areas include renewable energy, clean technology, water management, sustainable agriculture, healthcare access, and financial inclusion. The iShares Global Clean Energy ETF exemplifies this approach by investing specifically in companies involved in solar, wind, and other renewable energy sources.

Thematic investing differs from broad ESG approaches by concentrating on specific solutions rather than applying general ESG criteria across all sectors. This focused approach can offer higher growth potential but typically involves greater concentration risk.

Impact Investing
Impact investing seeks to generate measurable positive social or environmental outcomes alongside competitive financial returns. This approach targets specific problems and requires evidence of additionality- demonstrating that the investment creates positive change that wouldn’t occur otherwise. The Global Impact Investing Network reports that impact investing assets under management have grown to $1.6 trillion in 2024.¹⁷ ¹⁸

Impact investments often focus on underserved markets or pressing global challenges such as affordable healthcare, clean water access, financial inclusion, sustainable agriculture, and climate solutions. Examples include microfinance institutions serving underbanked populations, funds supporting affordable housing projects, and companies developing clean water solutions for developing regions. To be noted, unlike thematic investing, impact investing requires ongoing measurement and reporting of social and environmental outcomes, not just investment in relevant sectors.

Shareholder Engagement and Stewardship
Shareholder engagement uses ownership rights to influence corporate behavior and improve ESG practices through dialogue, proxy voting, and shareholder resolutions. This strategy recognises that investors can create positive change by actively engaging with companies rather than simply avoiding or divesting from problematic investments.

Engagement activities include regular dialogue with management, filing shareholder proposals, voting on proxy measures, and participating in collaborative initiatives with other investors. BlackRock reported conducting over 2,600 engagements with nearly 1,700 companies during 2019, focusing on issues like board diversity and climate risk disclosure.¹⁹

A cinematic example of ESG shareholder activism occurred in 2021 when Engine No. 1, a small hedge fund with just $40 million invested, successfully elected three directors to ExxonMobil’s board to promote climate-focused strategies.²⁰ This campaign demonstrated how strategic engagement can achieve significant influence even with modest shareholdings.

Norm-Based Screening
Norm-based screening evaluates companies based on compliance with internationally recognised standards and norms covering ESG factors. This approach screens investments according to frameworks established by organisations such as the United Nations Global Compact, OECD Guidelines for Multinational Enterprises, and International Labour Organization conventions.

Unlike values-based exclusions, norm-based screening focuses on minimum acceptable business conduct standards rather than sector preferences. Companies failing to comply with basic human rights, labour standards, environmental protections, or anti-corruption measures may be excluded regardless of their industry.

EUROFIMA exemplifies this approach by monitoring investee compliance with the Ten Principles of the UN Global Compact, derived from international human rights, labour, environmental, and anti-corruption standards. Non-compliant positions must be liquidated and business relationships terminated.²¹

Portfolio Tilting and Overweighting
Portfolio tilting adjusts portfolio weights to favour companies with higher ESG ratings while maintaining similar sector and risk characteristics to a benchmark index. This approach provides ESG exposure without dramatically altering portfolio diversification or risk profiles.

Rather than completely excluding companies or sectors, portfolio tilting reduces exposure to ESG laggards while increasing allocations to ESG leaders. A fund might replicate the Russell 3000 index structure but tilt toward companies with superior ESG scores, maintaining broad market exposure while expressing ESG preferences.

This strategy appeals to investors seeking ESG alignment without accepting significant tracking error relative to market benchmarks. The approach balances ESG considerations with traditional portfolio management objectives like diversification and risk control.

Double Materiality
Double materiality is the cornerstone of the European Union’s Corporate Sustainability Reporting Directive (CSRD). Double materiality looks at the company’s impact on the environment, which is seen in impact materiality and sustainability issues influence a company’s development, performance, and financial position, which is evaluated through financial materiality.

Choosing the Right Strategy
The selection of appropriate ESG strategies depends on individual investor priorities, risk tolerance, and desired level of impact. Many investors combine multiple approaches—using negative screening to exclude unacceptable investments while applying positive screening or ESG integration to select among remaining options.

Beginners often start with ESG mutual funds or ETFs that employ professional management and established methodologies. More sophisticated investors might combine thematic investments with shareholder engagement activities to maximise both financial returns and positive impact.

Who
Pension funds have emerged as significant drivers of ESG investment due to their long-term investment horizons and exposure to ESG-related downside risks.²² According to recent research, 71% of sovereign wealth fund respondents have adopted an ESG approach,²³ examples include Norway’s Government Pension Fund Global (GPFG), the world’s largest sovereign wealth fund at $1.3 trillion, which has become a stand-out example of responsible investing through negative screening and divestment from companies causing severe environmental damage.²⁴ Insurance companies are the third influencial group interested in the ESG investing, with 85% of global insurers believing ESG will impact all functions of their business. They identify investments as the single largest area of ESG impact, with 91% recognising significant implications.²⁵ Finally, asset management giants are the remaining very large investor: BlackRock now oversees roughly $320 billion of dedicated ESG funds,²⁶ Vanguard offers both exclusionary ESG funds that filter out certain sectors and actively managed products that allocate capital to companies with leading or improving ESG practices,²⁷ and State Street Global Advisors manages over $516 billion in ESG assets under management, comprising roughly 12.5% of the firm’s total assets under management as of 2021.²⁸

Current ESG Related Monetary Flows
The ESG fund flow landscape has experienced significant volatility in recent years. Global sustainable funds recorded the highest inflows of 2024 in the fourth quarter, reaching $16.0 billion. However, the first quarter of 2025 saw record outflows of $8.6 billion, marking the worst quarter on record.²⁹ ³⁰ The market showed signs of recovery in the second quarter of 2025 with net inflows of $4.9 billion, driven primarily by European investors who contributed $8.6 billion after redeeming $7.3 billion in the prior quarter.³¹

Global sustainable funds attracted $31 billion in net inflows during 2024, though this represented slower growth compared to previous years. The combined assets of mutual funds and ETFs investing according to ESG criteria increased by $8.43 billion to $605.23 billion in the United States alone.³² ³³

Meanwhile, Germany leads global ESG enforcement with the largest single penalty imposed on DWS (Deutsche Bank’s asset management arm), which paid €25 million ($27 million USD) in 2025 for greenwashing violations;³⁴ Australia has also demonstrated a comprehensive enforcement program with three major greenwashing penalties totaling $23.3 million USD in the last year;³⁵ ³⁶ ³⁷ United Kingdom reports £7.3 million ($7.3 million USD) in individual penalties during 2024/25, representing a 225% increase from the previous year;³⁸ and even the United States has fined $19 million across multiple actions.³⁹ ⁴⁰

Challenges and Market Evolution

The ESG landscape faces significant challenges from regulatory uncertainty and political backlash, particularly in the United States where ESG principles have become politically controversial.⁴¹
The absence of unified global ESG standards represents one of the most persistent challenges facing the sector. 25% of global investors identify inconsistency in ESG scores from different rating providers as their primary challenge, while 37% of executives highlight the lack of consistent reporting standards as a major operational obstacle.⁴² This fragmentation creates significant compliance burdens for multinational corporations. Companies operating across multiple jurisdictions must navigate the CSRD, TCFD, GRI, SASB, and ISSB standards, each with different disclosure requirements.
Columbia University and London School of Economics research comparing 147 ESG fund portfolios with 2,428 non-ESG portfolios found that companies in ESG portfolios had worse compliance records for both labor and environmental rules. These findings contribute to growing skepticism, with 53% of UK investors considering ESG factors in 2023, down from 65% in 2021.⁴³ ⁴⁴
46% of investors highlight the lack of comprehensive ESG data as a significant challenge , particularly for Scope 3 emissions and supply chain risk assessments.⁴⁵ ⁴⁶
Supply chain due diligence presents major compliance challenges, as most ESG risks occur outside an organisation’s direct operations. Companies must ensure their entire supply chain complies with ESG standards, which can be resource-intensive, particularly when dealing with suppliers in emerging markets that may lack resources or expertise to meet compliance standards.⁴⁷
There is a growing role of artificial intelligence and machine learning in ESG data collection and analysis. Technology solutions address the 46% of investors who identify lack of comprehensive ESG data as a significant challenge, representing a practical solution to implementation barriers.

In conclusion, understanding these diverse ESG investment strategies enables investors to construct portfolios that reflect their values while pursuing competitive financial returns and contributing to positive environmental, social, and/ or corporate governance changes, if they wish to do so.

ESG factors represent material business risks that directly impact financial performance, not ancillary social concerns: NYU Stern meta-analysis showing 58% positive relationships and 90% non-negative correlations between ESG performance and financial returns.⁴⁸ This positions ESG as fundamental risk management rather than values-based investing overlay. Therefore, companies that excel at managing these risks demonstrate superior long-term value creation, while those that ignore ESG factors face potentially catastrophic financial losses that can destroy decades of shareholder value.

Sources

Tag: adaptation-finance

ESG investing

Financing climate solutions – II: adaptation finance

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