"Everyone talks about ESG. Is it about saving the planet, avoiding risk or earning more — and what does it change for my portfolio?"
Three letters now appear in fund names, company reports, bank loan conditions and government regulations. For some people they stand for a moral commitment, for others a risk-management tool, for others a marketing slogan. This chapter cuts through the noise: it explains what environmental, social and governance factors are, why different investors care about them for different reasons, how to decide which issues matter for a given company, and which strategies investors use to put ESG into practice.
ESG stands for environmental, social and governance. It describes a family of non-financial factors — things that do not appear directly as lines in a company's income statement — that may nonetheless affect the company's long-term value, its impact on the world, or both. ESG investing is the use of these factors in investment decisions: which securities to buy, how much to hold, and how to behave as an owner.
The idea is old — religious investors avoided certain businesses centuries ago (Chapter 2) — but the scale is new. Since the mid-2000s, large pension funds, insurers and asset managers have adopted ESG language, data providers score thousands of companies, and regulators in many countries set rules on what companies and funds must disclose.
Several terms are used, often loosely, for overlapping ideas:
In this book, ESG investing means using ESG information in investment decisions, and sustainable investing the wider set of practices that also aim at real-world outcomes.
Each letter covers a long list of issues (Figure 1.1). None of the lists is official: data providers, standard setters and investors group the issues in slightly different ways, which is one reason ESG ratings disagree (Chapter 5).

The environmental pillar covers how a company affects, and depends on, the natural world. Climate change dominates the debate: greenhouse gas emissions (Chapter 6) and exposure to carbon policy and extreme weather. Other issues include energy and water use, pollution, waste, and land use and biodiversity (Chapter 21).
The social pillar covers relationships with people: employees, workers in the supply chain, customers and local communities. Typical issues are health and safety, wages, forced and child labour, discrimination, product safety, data privacy and relations with communities near mines, plants or plantations. Social issues are harder to measure than environmental ones and are often revealed through incidents rather than reported figures.
The governance pillar covers how the company is directed and controlled: board independence, executive pay, minority shareholder rights, related-party transactions, accounting quality, tax practices and corruption. Governance is the foundation of the other two: a company with weak controls is unlikely to manage its environmental and social risks well, and it is the pillar most clearly linked to large losses for investors (Chapter 3).
| Pillar | Examples of issues | Examples of indicators |
|---|---|---|
| Environmental | Climate change, energy, water, pollution, waste, biodiversity | Tonnes of CO2-equivalent emitted, energy intensity, water withdrawn, spills, share of renewable power |
| Social | Labour standards, health and safety, supply chains, product safety, data privacy, communities | Injury rates, staff turnover, supplier audits, product recalls, data breaches, community disputes |
| Governance | Board structure, executive pay, shareholder rights, ethics, accounting, tax | Share of independent directors, pay ratio, related-party transactions, fines, audit opinions |
Two investors may buy the same "ESG fund" for completely different reasons. Being clear about one's own reason is the most useful first step, because it decides which strategy and product fit.
| Motivation | Main goal | Typical strategies | How success is judged |
|---|---|---|---|
| Values | Align the portfolio with beliefs | Exclusions, norms-based screens, faith-based rules | The portfolio holds nothing the investor objects to |
| Risk and return | Better risk-adjusted performance | ESG integration, best-in-class, ESG tilts | Lower risk or higher return than a comparable portfolio |
| Impact | Contribute to measurable change | Impact funds, thematic investing, engagement, green bonds | Measured outcomes: emissions avoided, jobs, access to services |
The motives can conflict. Excluding an oil company may satisfy an investor's values while having little effect on the company, which simply finds other shareholders. Engaging with it may achieve more change but means owning a business the investor dislikes. None of these choices is wrong; each answers a different question.
In accounting, an item is material if leaving it out could change the decisions of a reasonable user of the accounts. ESG investing borrows the word. An ESG issue is financially material if it can reasonably be expected to affect a company's cash flows, its risks or its cost of capital — and therefore its value.
Materiality depends on the industry. Water scarcity is a major risk for a beverage company or a rice exporter and nearly irrelevant for an insurance broker; data privacy is critical for a bank but minor for a cement maker. This is why most rating systems use industry-specific weights (Figure 1.2): the same score on the environmental pillar counts for half of the total for an oil company but only a small fraction for a software firm. The standards originally developed by the US-based Sustainability Accounting Standards Board (SASB), now maintained by the ISSB, are built on this idea, identifying the disclosure topics most likely to be material for each of dozens of industries (Chapter 4).

Each pillar score is measured on a common scale, for example 0 to 100, and the weights w(E), w(S) and w(G) add up to 100%. The weights depend on the industry: they reflect how material each pillar is for that kind of business. Real ratings use many more issues and sub-scores, but the logic is the same (Chapter 5).
Three hypothetical companies have identical pillar scores: environmental 40, social 70 and governance 80. They operate in different industries, so their materiality weights differ, as in Figure 1.2.
The weak environmental score barely hurts the bank but weighs heavily on the oil producer. An overall ESG score is never just "how green" a company is: it is a judgement about which issues matter for its business.
Materiality also changes over time. Twenty years ago, few investors called carbon emissions material for a carmaker; carbon prices, fuel-efficiency rules and electric vehicles have since made them central. Issues that look like ethics today can become finance tomorrow — dynamic materiality.
Financial materiality looks from the outside in: how does the world affect the company? Double materiality adds a second direction, from the inside out: how does the company affect the world — people, communities and the environment — whether or not this affects its profits today?
A factory that pollutes a river may face no fines or lawsuits, so its pollution is not, for now, financially material; under double materiality it still is. The European Union adopted this approach in its corporate sustainability reporting rules, while the global baseline standards of the International Sustainability Standards Board (ISSB) focus on information that is material to investors (Chapter 7). Impacts ignored today often return as regulation, litigation or lost customers tomorrow (Chapter 3).
Investors put ESG into practice through a small number of strategies; the classification below is close to that of the Global Sustainable Investment Alliance. Module 3 gives each strategy its own chapter.
| Strategy | What it does | Typical tool | Chapter |
|---|---|---|---|
| Exclusions (negative screening) | Removes companies or sectors judged harmful, often above a revenue threshold | Lists of activities, revenue limits | 8 |
| Norms-based screening | Removes companies that breach international norms on human rights, labour, environment or corruption | UN Global Compact, OECD guidelines | 8 |
| ESG integration | Adds ESG information to financial analysis of risks and value | Analyst research, adjusted forecasts | 9 |
| Best-in-class (positive screening) | Selects the leaders within each sector on ESG criteria | ESG scores, sector rankings | 9 |
| Thematic investing | Invests in companies whose products address sustainability challenges | Revenue from clean energy, water, health | 10 |
| Impact investing | Targets measurable positive outcomes with a financial return | Impact metrics, private markets | 10 |
| Stewardship and engagement | Uses shareholder rights to push companies to change | Dialogue, voting, resolutions | 11 |
| Labelled bonds | Finances eligible green or social projects, or links coupons to targets | Green, social and sustainability-linked bonds | 12 |
Exclusions are simple and easy to explain, but say nothing about the companies that remain. Integration is invisible from the outside. Best-in-class keeps sector weights close to the market, but can include "the best of the oil companies". Thematic and impact strategies are concentrated and volatile. Stewardship changes no holdings at all; its results show up, if at all, in the behaviour of companies.
Almost every ESG portfolio combines strategies. A common recipe: exclude controversial weapons, tobacco, thermal coal and norm breakers; overweight the best ESG scores in each sector; then vote and engage. The NXW Global ESG Leaders index (NXWGLESG, simulated), used as a running example in this book, follows a similar logic: 50 components, rebalanced once a year, with cap weights tilted towards companies with higher ESG scores. Chapter 15 describes its methodology, and Chapter 19 shows how to build and back-test such an index.
The usual way to summarise the ESG profile of a portfolio is a weighted average of the scores of its holdings.
A portfolio holds five hypothetical companies, with weights of 30%, 25%, 20%, 15% and 10% and ESG scores of 72, 65, 58, 30 and 80. Company D, with the 15% weight and the score of 30, is a coal-heavy power producer.
The score rises by more than five points without any company changing its behaviour. That is a legitimate result for a values-based investor, but it is not evidence of real-world impact — a distinction this book returns to in Chapters 10 and 17.
Because the term is used so widely, it helps to clear up a few common misunderstandings.
Critics argue that ESG mixes incompatible goals, relies on poor data and invites greenwashing; supporters reply that ignoring material risks is itself a failure of fiduciary duty. This book takes a practical position: ESG information is useful when it is material, measured carefully and used for a clearly stated purpose — and much less useful as a slogan.
ESG may seem like a concern of large Western pension funds, but it already shapes Vietnamese companies, banks and capital markets.
For a Vietnamese investor the questions are the same as everywhere — which issues are material, what should my money achieve, which products deliver it cheaply? — but data are thinner and products fewer. Chapter 20 returns to these questions, and Chapter 18 builds an illustrative ESG portfolio in VND.
This book follows the same path as its companions, Index Investing: From Theory to Practice and Commodity Investing: From Theory to Practice. It is organised in six modules.
Each chapter ends with key takeaways, a practice lab with an Excel workbook and further reading. Simulated and illustrative data are always labelled.
Download the workbook Lab01_What_Is_ESG.xlsx from the companion site.