- An ESG investment policy belongs in the eligible investments and restrictions section of the IPS, written as criteria an advisor can apply and a committee can verify.
- ESG policy language should answer four questions: which ESG factors matter, whether they weight holdings or exclude them, what the criteria apply to, and which rating methodology and responsible party applies them.
- An ESG portfolio benefits from being reported against two benchmarks, the standard index the IPS already uses and the ESG version of the same index, so the committee can see the effect of the criteria separately from the advisor’s other decisions.
- ESG oversight is mostly routine: confirm each fund’s methodology matches the policy, review compliance and both benchmarks quarterly, and revisit the criteria with the rest of the IPS.
- Requests to add or change ESG criteria should go through the policy process rather than being handled one at a time.
Once a board has decided to integrate ESG investing into its nonprofit or association’s reserves portfolio, the next step is a set of conversations to settle which factors matter and how strictly they apply, and then to add those criteria to the investment policy statement (IPS) as the organization’s ESG investment policy.
This article covers the section of the IPS where ESG criteria belong, the decisions the policy language needs to capture, how to benchmark the portfolio once the criteria are in place, and how a finance committee oversees ESG investments as a fiduciary from that point on. SRI exclusions and impact allocations are written into the same section and follow the same structure. If your board is still deciding among ESG, SRI, and impact approaches, our article on how to choose between ESG, SRI, and impact investing covers that decision.
Where an ESG Investment Policy Belongs in the IPS
Before the language is drafted, it is generally helpful for the committee to work through four decisions, and the policy should record each one: which ESG factors matter to the organization, whether those factors weight holdings or exclude them, what the criteria apply to, and which rating methodology and responsible party applies them.
1) Which ESG Factors Matter?
The factors that belong in the policy are the ones that connect to the organization’s mission. Environmental, social, and governance cover a wide range, and a policy that names all three without saying which ones the board cares about leaves the choice to the fund provider. Name the factors that connect to the mission: carbon intensity and environmental disclosure for an environmental organization, labor practices and product safety for a health organization, board independence and executive pay for an organization focused on governance.
2) Weight or Exclude?
ESG integration keeps every sector and holds more of the companies that score well on the chosen factors and less of those that score poorly. An ESG rating screen removes companies that fall below a stated threshold on the rating firm’s scale, or that carry a severe controversy flag, regardless of the industry they are in. Because integration keeps every company and only changes how much of each the portfolio holds, it generally stays closer to the standard benchmark than a rating screen, which removes companies outright and narrows the investable universe.
The policy should state whether the board chose integration or a rating screen and, for a screen, the threshold and whose rating scale it refers to. Excluding companies by industry or activity, such as tobacco or weapons, is an SRI screen rather than an ESG one, though it is written into the same section of the IPS.
3) What Do the Criteria Apply To?
The policy should state which asset classes and which pools the ESG criteria cover. Because most nonprofit and association portfolios are built from mutual funds and ETFs, ESG criteria are applied by selecting ESG-integrated or ESG-screened funds, and the choice of such funds is wider in equities than in fixed income, where ESG bond funds are fewer and newer. Many organizations apply the criteria to the equity allocation first and extend them to fixed income as suitable funds become available. On pools, many organizations apply ESG criteria to long-term reserves and leave operating reserves and short-term pools unscreened, since those pools are held for liquidity rather than long-term growth. If the organization holds individual securities through a separately managed account, the policy should say whether the criteria apply there as well.
4) Whose Methodology, and Who Applies It?
In most cases the advisor applies the criteria when funds are selected and reports on them afterward, and the board retains its governance responsibility for confirming that the portfolio stays in line with the IPS. The policy should say so. It should also require the advisor to identify the rating methodology and data provider behind each fund, since ESG scores are produced by third-party rating firms and the same company can score well with one firm and poorly with another.
Sample ESG Policy Language
The following passages are illustrative examples of how the four decisions above can be written for ESG integration and for an ESG rating screen. Each passage names the factors or the rating threshold, a scope (the Long-Term Reserve Pool), a responsible party (the Advisor), a reporting obligation, and the two benchmarks the results will be measured against. They are starting points for a committee and its counsel to adapt, not language to adopt as written.
ESG Integration
Within the equity allocation of the Long-Term Reserve, at least [80] percent of assets will be held in pooled investment vehicles that incorporate environmental, social, and governance criteria in security selection or weighting, with particular attention to [carbon intensity and environmental disclosure]. This requirement does not call for the exclusion of any sector. The Advisor will identify the ESG methodology and data provider used by each selected vehicle, confirm that it is consistent with the factors named in this Policy, confirm compliance with this section in each quarterly report, and report annually on whether each vehicle’s methodology remains consistent with the Organization’s stated values. Performance of the equity allocation will be reported against both the [standard index] and the [ESG index] named in the Benchmarks section of this Policy.
ESG Rating Screen
Within the Long-Term Reserve, the Organization will not hold direct investments in, and will select pooled investment vehicles that exclude, companies rated below [the stated threshold] on the ESG rating scale of the data provider used by the selected vehicle, or flagged by that provider for a severe ESG controversy. The Advisor will identify the data provider and threshold applied by each vehicle and confirm that they are consistent with the factors named in this Policy. If a holding falls below the threshold after purchase, it will be sold within [90] days or during the next rebalancing, whichever comes first, and the exception will be noted in the next quarterly report. The Advisor is responsible for selecting compliant investments and for confirming compliance in each quarterly report. Performance will be reported against both the [standard index] and the [ESG index] named in the Benchmarks section of this Policy.
Language to Avoid
A common weakness in ESG policy language is a statement of intent with no criterion attached. “The Committee will consider ESG factors where appropriate” or “The Organization seeks to invest sustainably” commits the organization to nothing an advisor can act on or a committee can check.
Schedule a conversation to discuss how your organization can implement ESG investing within your investment portfolio. Meet with a Raffa Advisor
How to Benchmark an ESG Portfolio
Once ESG criteria are implemented, committees generally need two benchmarks to measure performance:
- the standard broad-market benchmark already listed in the IPS
- the ESG version of that same benchmark where the index provider publishes one, such as the S&P 500 Scored & Screened Index (formerly the S&P 500 ESG Index) alongside the S&P 500, or otherwise an ESG index drawn from the same market
The standard benchmark shows what the portfolio would have been measured against without any criteria. The ESG benchmark shows what a portfolio built on similar criteria returned over the same period, before the advisor’s fund selection, allocation, and costs come into it. Together they help the committee approximate the two effects: the gap between the standard and ESG benchmarks gives a rough measure of what the criteria cost or added, and the gap between the ESG benchmark and the portfolio reflects the advisor’s decisions as well as any differences between the index’s criteria and the IPS.
An ESG index is a version of a standard market index that applies ESG or exclusion criteria. For U.S. large-company stocks, the S&P 500 Scored & Screened Index and the MSCI KLD 400 Social Index are commonly used alongside the S&P 500. For global stocks, MSCI publishes ESG Leaders and ESG Screened versions of the MSCI ACWI, and bond index providers publish ESG-weighted versions of the broad aggregate bond indexes. These are illustrative examples, not recommendations. A board’s own factors and thresholds will rarely match any published index exactly, so the right ESG index is the one whose methodology most closely resembles the criteria in the IPS, and the IPS should name it as the closest available comparison.
ESG Oversight: Managing ESG Investments as a Fiduciary
Once the criteria are in place, ESG oversight is mostly work the committee already does, with a few items added: confirm that the investments are aligned with the policy, review the results on the schedule the committee already keeps, and handle changes through the policy rather than around it.
ESG Due Diligence on Funds and Managers
ESG due diligence is confirmation by the finance committee, usually through information provided by the advisor, that each fund in the portfolio applies criteria consistent with the IPS. Boards and committees are responsible for that confirmation, and a fund’s name alone does not provide it. For each fund, the committee should know which rating methodology it uses, which data provider supplies the ratings, and whether its holdings are consistent with the policy. This matters because ESG ratings differ materially across providers, and because fund labels change: a fund can drop “ESG” from its name and keep the same process, or keep the name and change the process.
A fund selected because it carried an ESG label may hold companies the board intended to exclude, and a fund with no label may satisfy the policy completely. Reviewing the holdings against the criteria at least annually generally settles the question.
Quarterly ESG Monitoring
Quarterly investment reporting for an ESG portfolio generally should add three items to the standard report: a statement that the portfolio complied with the criteria during the period, with any exceptions and how they were resolved; performance against both the standard benchmark and the ESG index; and the cost of the ESG funds compared to the unscreened alternatives the portfolio would otherwise hold. These are generally additional lines in the report the committee already reviews, not a separate report.
Annual Review and Triggers
ESG criteria should be reviewed on the same schedule as the rest of the IPS, typically annually. The annual review asks whether the factors still reflect the organization’s values, whether the difference from the standard benchmark has stayed within what the board said it would accept, whether any fund has changed its methodology or data provider, and whether the ESG index is still the closest available comparison. Certain events should prompt a review out of cycle: a change to the mission statement, a change of advisor or fund lineup, a fund dropping or adding an ESG methodology, or a benchmark difference materially larger than expected.
Handling Requests to Change the Criteria
Requests to add, remove, or tighten ESG criteria often come from donors, members, staff, and new board members. The fiduciary approach is to route every such request through the same process the original decision used: the committee considers it, weighs the trade-off, and either recommends a policy change to the board or documents why it declined. Handling requests one at a time, outside the policy, is how a portfolio can end up with criteria no one can explain.
How Raffa Supports ESG Policy and Oversight
Raffa manages investment portfolios for nonprofits and associations, and applying a board’s ESG criteria is part of that work. Raffa can assist in drafting the ESG language for the investment policy statement, select the ESG index that reflects the board’s criteria as closely as available indexes allow, build and manage the portfolio to those criteria, and report performance against both benchmarks each quarter. Our values-based and ESG investing work rests on the principle that the criteria belong to the board and the advisor’s job is to apply them consistently and show the committee the effect of its decision.
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About the author
Matt O'Lone
Matt O’Lone is a Portfolio Manager at Raffa Investment Advisers and serves as Relationship Manager and Lead Adviser for nonprofit organizations, associations, and other institutional clients. Through this role, he works closely with boards, finance committees, and staff to help align investment strategy with organizational objectives, risk tolerance, and governance requirements. As an active member in the nonprofit and association community, Matt has participated as a panelist and event host for organizations including the Nonprofit Resource Hub, NoVa Association of Executives, and the Greater Washington Society of CPAs.
Frequently Asked Questions: ESG Investment Policy
What is an ESG investment policy?
An ESG investment policy is the section of an organization’s investment policy statement that states how environmental, social, and governance criteria apply to the portfolio. It names the factors that matter, whether they weight holdings or exclude them, the pools they apply to, and who is responsible for applying them. It is part of the IPS rather than a separate document, and SRI exclusions and impact allocations are written into the same section.
What is ESG screening?
ESG screening is the practice of removing companies from an investment universe based on their environmental, social, and governance ratings, typically those rated below a set threshold by the fund’s data provider or flagged for a severe controversy. It differs from ESG integration, which keeps every company and adjusts weights by score, and from SRI screening, which removes companies by activity, such as tobacco, rather than by rating.
Learn more how to Choose Between ESG, SRI, and Impact in our recent article.
What is an ESG index?
An ESG index is a published index that applies ESG or exclusion criteria to a standard market index, such as the S&P 500 ESG Index alongside the S&P 500. Used this way, it serves as the ESG benchmark for an ESG portfolio, reported next to the standard index so the committee can see the effect of the criteria.
What is ESG monitoring?
ESG monitoring is the ongoing review of whether a portfolio continues to comply with its ESG criteria and how those criteria are affecting results. For a finance committee, it means a quarterly compliance confirmation, performance reported against both a standard benchmark and an ESG index, and an annual review of each fund’s holdings and methodology.
Disclosures
Raffa Investment Advisers is a registered investment adviser with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training.
All investments involve risk, including the possible loss of principal. Past performance is not indicative of future results. Indexes are unmanaged and cannot be invested in directly. References to specific indexes are illustrative examples of commonly used benchmarks and are not recommendations. Any forward-looking statements are based on current expectations and are subject to uncertainties.
Values-based, ESG, and impact investing strategies may limit the universe of available investments and may perform differently from the broad market. Third-party ESG ratings and screening methodologies vary and may not reflect an organization’s own criteria. References to specific fund categories or industry data are for illustration and are not recommendations.
This article is for informational purposes only and should not be construed as personalized investment advice. It does not constitute legal or tax advice. Raffa Investment Advisers does not provide legal or tax services. Organizations should consult qualified legal counsel regarding the fiduciary standards that apply to them.
Portions of this article were drafted with the assistance of AI tools and reviewed by Raffa Investment Advisers staff for accuracy and compliance.