What You Need To Know About ESG Investing

Lisa Smith, BA (Hons), CeFA

ESG investing is a buzz word sweeping around fund managers, market analysts and stock pickers.

Why is ESG becoming so popular?

Well, as an investor, looking at investments through ESG glasses can reduce risk, generate good returns while making everyone feel good about their investment choices.

No wonder funnelling wealth to save the planet while reaping a financial benefit is taking the investment world by storm.

So, if you want to find out more about how you can invest ethically with ESG, here’s some of the most frequently asked questions about ESG answered.

What does ESG stand for?

ESG comes from three ways of looking at investments. Some of the topics are outlined here, but the list is not exhaustive but more a starting point for an ESG investor to build their own checklist.

Environmental – The aim is to look at how a company’s operations impact the planet.

Factors to score range widely between investors, but can include:

  • How is the company dealing with climate change issues?
  • What is being done to reduce greenhouse gases and the corporate carbon footprint?
  • Does the company have policies to reduce waste, emissions and utilities, such as water, gas and electricity usage?
  • What are the policies towards recycling and renewable energies?

Social – This is looking at how the company interacts with staff, customers and the public at large.

Good sources of information are ‘best company to work for’ lists, employee insights on web site Glassdoor, employment tribunal cases and how the brand is generally perceived.

Other topics to consider are diversity and inclusion for staff.

Governance – This examines how the company is run from the top down.

Lots of topics are covered, such as corporate pay structures, how the board is made up and votes, relationships with industry bodies and regulators and dealings with shareholders.

ESG is more than a stock-picking algorithm, it’s a philosophy and is almost an extension of a the ‘woke’ lifestyle.

Woke is a political term that celebrates awareness of social and racial justice, which derives from the townships of South Africa.

Investing in ESG funds and companies

The growing green army of ethical ESG investors picked up returns of up to 32% last year, with the worst performing still returning 3.7%, according to market monitor Morningstar.

Ignoring returns and looking at sustainability, the Schroders and Axa funds listed below rate only average, while the rest are above average or high.

The worst performer was identified as the Stewart Investors Asia Pacific Leaders Fund, returning 3.7%.

But, says Morningstar, performance is not the prime tool  when scrutinising the suitability of ESG investments as how ESG strategy aligns with those of the investor also count.

The research identified the top 10 ESG performers as:

NameTotal Return
Pictet Global Environmental  Opportunities31.90%
Schroder Global Cities RE29.30%
Pictet Security28.40%
Liontrust UK Ethical28.30%
Pictet Clean Energy27.70%
Robeco Mega Trends27.50%
BNP Paribas Climate Impact27.30%
Pictet Water26.20%
LO Funds Generation Global25.60%
Morgan Stanley US Advantage25.50%

Source: Morningstar

Setting your ESG exclusion zone

Investors must think long and hard about what they want from the companies or funds they buy shares in.

Many favour funds as the managers do all the ESG analysis as part of their service.

Filtering out the stuff that worries an ESG investor is generally the starting point. Companies involved with weapons, tobacco and alcohol are a starting point, then companies that struggle with their green credentials.

Others that miss the cut could include those that exploit emerging market labour forces, have large carbon footprints because their factories pollute or their products and raw materials go on long journeys to market.

If you want help assessing ESG companies, the Sustainability Accounting Standards Board (SASB) has a free materiality map online.

The map is a deep analysis of a companies ESG credentials that examines how businesses in different sectors measure up to the expectations of a responsible investor.

How ESG investing may cancel out risk

Risk is an integral part of investing. Risk covers a wide range of factors, from regulatory action to damage to reputation and how economic and political events can steamroller profits.

The thinking is many of these risks are smoothed by an ESG audit, because an ethical and friendly business should already have mitigated many of these issues.

Many analysts also class ESG compliance with effective management.

Who are the likely ESG investors?

Anyone can adopt an ESG strategy for investment – there’s no secret society or membership tests.

The key demographic, according to reams of research, is the millennial, who is twice as likely than any other age group to consider an ESG investment plan.

This age group – born between 1981 and 1996 – are just coming of age as investors in that they are reaching a life stage which should free up some income for investment.

What are the downsides of ESG investing?

ESG investing comes with the same downside of any other investment strategy.

Taking an ESG view offers no guarantees of profit or performance, even though investors would hope that their thorough due diligence offers a little more safety than the general marketplace.

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