February 23, 2024

ESG Investments: The Intersection of Mission, Risk, and Return

By Michael J. Feroz, CPA, Director, Assurance Services

ESG Investments: The Intersection of Mission, Risk, and Return Nonprofit & Social Sector

As awareness of environmental, social, and governmental (ESG) issues continues to increase, nonprofit organizations are finding innovative ways to align their missions with sustainable practices. One avenue is the integration of ESG investments into their financial strategies. By taking this approach, organizations can not only aim for financial stability but also strive to contribute to positive change in the world. This article explores how nonprofit organizations can consider employing ESG investments to fulfill their missions as well as the potential trade-offs and impacts of such decisions.

Understanding ESG Investments

ESG investments refer to a set of criteria that investors use to evaluate a company’s impact on the environment, society, and governance practices. Environmental factors include a company’s carbon footprint and resource use, social factors encompass labor practices and community engagement, and governance involves issues like transparency and accountability.

Nonprofits are increasingly recognizing the potential for ESG investments to align with their core values and amplify their impact. By incorporating ESG criteria into their investment strategies, these organizations can make socially responsible choices that resonate with their missions.

ESG Investments and Environmental Impact

Renewable Energy and Conservation Projects: Nonprofits focused on environmental conservation can leverage ESG investments to fund renewable energy projects or initiatives that promote sustainable resource use. Investing in solar or wind energy, for instance, may not only align with the organization’s mission but also contribute to the global shift towards cleaner energy sources.

Sustainable Agriculture: Nonprofits working in the realm of food security or sustainable agriculture can channel ESG investments into enterprises that prioritize ethical farming practices, biodiversity conservation, and waste reduction. Such investments can help support the development of environmentally friendly farming methods.

Conservation Finance: ESG investments can be directed towards conservation finance, including the protection of endangered ecosystems, wildlife habitats, and biodiversity hotspots. Nonprofits engaged in preserving natural resources and wildlife can use funds to support initiatives that safeguard the environment for future generations.

ESG Investments and Social Impact

Affordable Housing Initiatives: Nonprofit organizations addressing social issues such as homelessness or inadequate housing can utilize ESG investments to support affordable housing projects. These investments can prioritize companies that are committed to fair labor practices and ethical housing development.

Education and Skill Development: Nonprofits dedicated to education and skill development can align their investments with ESG criteria by supporting companies with strong commitments to diversity, equitable employment practices, and community engagement. This can ensure that their financial resources contribute not only to the organization’s profits but also to broader social development.

Healthcare Access: ESG investments can play a pivotal role in supporting nonprofits focused on healthcare access. By investing in companies that prioritize affordable healthcare solutions, ethical pharmaceutical practices, and community health programs, nonprofits can amplify their impact on societal well-being.

ESG Investments and Governance

Ethical Supply Chains: Nonprofit organizations concerned with fair trade and ethical business practices can integrate ESG investments to support companies committed to transparent and responsible supply chains. This can help ensure that their investment decisions align with principles of good governance.

Corporate Social Responsibility (CSR) Initiatives: Nonprofits can identify companies with strong CSR initiatives for their ESG investments. These initiatives often reflect a commitment to social and environmental causes, demonstrating the company’s dedication to responsible business practices.

Gender Diversity and Inclusion: Governance-focused ESG investments can be directed towards companies that prioritize gender diversity and inclusion in their leadership and workforce. Nonprofits can leverage these investments to support organizations that are committed to promoting equality and fairness in the workplace.

Challenges and Accounting Considerations

While the integration of ESG investments offers numerous benefits for nonprofits, there are challenges and considerations that organizations must navigate. From a purely financial standpoint, the greatest concern when considering a change to ESG investments is the potential for limited returns when compared to more traditional investments. A nonprofit’s greatest impact is through the work they perform towards their mission, largely leveraging program related expenses which are enabled from the contributions, support and fees collected. The last thing an investment strategy should do is take away an organization’s ability to do this work. Nonprofits should carefully balance their financial goals with their commitment to sustainability. It is imperative for nonprofits to update and continuously evaluate their investment policy to ensure compliance with the approved targets.

Another challenging area involves access to reliable and verifiable ESG data. There are a myriad of measures, scales, and inputs that can be compiled for evaluating ESG, which can be overwhelming for a nonprofit to interpret on their own. With so much subjectivity around ESG criteria, there is not currently a uniform measure to evaluate these non-financial components. Efforts are being made to develop standards, but these are still very much in the infant stage of their overall status. Collaborating with specialized ESG data providers and financial institutions can help address this issue. A growing number of investment advisors are offering a more comprehensive and detailed overview of how ESG investments are evaluated, which can be incorporated into a nonprofit’s pursuit of these investments.

Lastly, transitioning into ESG funds involves specific accounting considerations for nonprofit organizations. Here’s an overview of key accounting considerations for nonprofits moving into ESG funds:

  1. Recognition and Measurement: Nonprofit organizations must adhere to accounting principles when recognizing and measuring ESG investments. These investments should be recorded at fair value on the statement of financial position. Fair value considerations may involve periodic valuations, and nonprofits should be transparent about the methods used to determine fair value.
  2. Disclosure Requirements: Transparency is essential when it comes to ESG investments. Nonprofits should consider enhancing their financial statement disclosures to provide stakeholders with insight into the nature and impact of their ESG investments. Disclosures may include details on the specific ESG criteria applied, the impact on the organization’s mission, and any risks associated with these investments.
  3. Valuation Techniques: ESG investments may be less straightforward to value compared to traditional investments. Nonprofits may need to employ various valuation techniques, including market comparisons, income approaches, or discounted cash flow models. Consistency in applying valuation methods is crucial for accurate financial reporting.
  4. Risk Assessment: Nonprofits should conduct a thorough risk assessment related to their ESG investments. Risks may include market risk, liquidity risk, and reputational risk. Understanding and appropriately disclosing these risks in financial statements helps stakeholders make informed decisions.
  5. Internal Controls: Establishing and maintaining robust internal controls is essential when managing ESG investments. Nonprofits should have procedures in place to monitor and evaluate the fair value of these investments, ensure accuracy in financial reporting, and enforce the appropriate segregation of duties while adhering to their board approved investment policy.

As nonprofit organizations navigate the complexities of ESG investments, collaboration between finance, accounting, and mission-focused teams is critical. By addressing these accounting considerations thoughtfully, nonprofits can not only further their mission through socially responsible investments but also maintain transparency and accountability in their financial reporting.