Media attention is stimulating huge interest in environmental, social, and governance (ESG) investments but, because companies have different ethical strategies, it can be difficult to know where and how to invest.
Environmentally friendly investing has been growing at a rapid rate. Morningstar reported that 169 new ESG funds launched during the first quarter of 2021 alone. And there’s around 343 sustainable investment funds available to UK investors.
According to Bloomberg, global ESG assets are expected to exceed $53 trillion by 2025. This represents more than a third of the $140.5 trillion in projected total assets under management.
As opportunities to invest with an ESG focus continue to grow, we predict that all investments are likely to be relatively compliant with ESG values within the next few years. In fact, if you already have an investment portfolio, chances are at least some of the stocks you’re holding will be in ESG companies, they just didn’t come with a specific “ESG” label at the time you invested.
With all this in mind, here are a few things to consider when you want to invest with ethical principles at the heart of your investment portfolio.
ESG investing isn’t only about protecting the planet
The environmental aspect of ESG gets the most attention, but ESG investing isn’t only about protecting the planet. Here’s how it breaks down…
Environmental factors look at the conservation of the natural world, such as how much water a company uses in their manufacturing process. Other environmental considerations might include:
- Carbon emissions
- Air and water pollution
- Deforestation
- Green energy initiatives
- Waste management.
Social factors examine the treatment of people both inside and outside the company, employee diversity, for example, or whether the company pays more than the minimum wage. Other social considerations include:
- Employee gender and diversity
- Data security
- Customer satisfaction
- Company sexual harassment policies
- Human rights at home and abroad
- Fair labour practices.
Governance factors consider how a company is run. An example of good governance would include a company whose founder doesn’t hold majority voting rights. Other governance considerations might include:
- Diversity of board members
- Political contributions
- Executive pay
- Large-scale lawsuits
- Internal corruption.
If you’re interested in investing with an emphasis on protecting the world we live in, start by understanding those areas you care about most.
If climate change is top of your concerns, you might want to avoid investing in fossil fuel companies. But if your focus is on wider societal issues, you may want to ensure you’re investing in companies that treat their employees well.
Because of the wide-ranging elements of ESG, and the investment decisions available, responsible investing becomes highly subjective.
What matters most to you may be less important to someone else. As a result, even when investment opportunities are promoted as “sustainable” or “responsible”, they may not match your own ethical criteria.
If you are investing as a couple, it’s important to discuss your views and beliefs so that you can agree an investment strategy that takes account of the values you each hold.
What wouldn’t count as ESG?
Non-ESG companies include producers or manufacturers of adult entertainment, alcohol, firearms, fossil fuels, gambling, nuclear energy, and tobacco.
Negative screening is just one of the approaches to ESG investing. Negative, or exclusionary screening, rules out or limits exposure to those companies or countries that engage in, or support, activities that investors wish to avoid.
The goal of negative screening is usually to avoid co-profiting from or financing an activity that fails to support an investor’s values.
Some of these firms may get higher ESG ratings than thought if they have plans in place to change their business models to better align with ESG principles.
For example, you may expect that a petroleum firm such as Shell wouldn’t rate as ESG compliant, but this isn’t necessarily the case as their business model is moving towards green energy solutions.
The problem of “greenwashing”
Unfortunately, there isn’t yet an official standard for ESG investments. This has led to firms launching so-called “sustainable” or “green” funds that make claims that often fall short of what investors believe they are buying.
This is called “greenwashing”.
By providing misleading information, companies or funds give a false impression of how environmentally friendly they are. This can make it even more difficult to determine which investments fit your personal criteria.
The Financial Conduct Authority (FCA) is aware of this problem and there have been reports that they intend to come up with new proposals by spring 2022. And, in late 2021, an advisory group, overseen by the FCA, met for the first time to discuss how ESG fund labelling could be improved.
With so much attention on ESG and the new regulation that is likely to be implemented, you may wish to wait until the FCA have completed their research before you commit your funds to ESG.
A global standard of ESG labelling is likely to arrive within a year or two. So, waiting until there’s a more widely accepted measure companies must attain to gain a recognised ESG rating may also help you avoid the potential of buying an investment that has been “greenwashed”.
We can all do our bit to help look after the environment
If caring for the environment is your greatest concern, adjusting your lifestyle to adopt greener habits in your day-to-day life can also help.
In some cases, reducing your carbon footprint might go further to help the environment than choosing ESG funds for your investment portfolio.
For example, recycling, reducing your use of plastic, buying unpackaged, fresh, seasonal produce, and switching to cycling or walking instead of driving for local trips can all add up to make a difference.
On the other end of scale, reducing the number of long-haul flights you take in a year can make a significant difference to your overall impact on the environment.
There is little research around returns you might expect on an ESG-focused portfolio, however…
Once you find companies that score high on ESG, you often discover that they are also well-run businesses.
Because they treat their stakeholders well, address their environmental challenges, and have lower levels of controversies, these high-scoring ESG firms are often more resilient during market downturns.
Since ESG investing is still relatively new, there is little research to reveal real returns you might be able to expect on an ESG-focused portfolio. However, research published in the Financial Times found that “close to 6 out of 10 sustainable funds delivered higher returns than equivalent conventional funds over the past decade”.
In fact, a study, conducted by Morningstar during 2020, found that the majority of ESG strategies performed better than non-ESG funds over one, three, five, and 10 years.
Remember, ESG factors are no guarantee of investment performance. As with any stock market investment, you may still experience short-term volatility and there is always some risk involved.
One of the most important aspects for long-term investment performance is having a well-diversified portfolio across different asset classes and geographies. If you’re 100% committed to investing with a purely ESG focus, it’s still vital you ensure your portfolio doesn’t end up too focused and narrow the range of investments you hold.
How Berry & Oak can help
The ESG market is still growing and we’re always working to keep up with what is available, finding those funds that will put your money to work while doing good.
Because there’s no one-size-fits-all solution, there are multiple ways to incorporate sustainable objectives into your investment portfolio while balancing this with your goals and risk profile.
We can help you understand all your options. We’ll go through the information and discuss the approach you wish to take in building your investment portfolio.
Get in touch
If you’d like to learn more about ESG investing and how you can invest your money and do good for the world, please get in touch. Email clientservice@berryandoak.com or call 01937 223055.
The value of your investment can fall as well as rise and is not guaranteed.
