Introduction to ESG investing

In recent years, there has been a huge surge in demand for ethical investments. Recent data from Morningstar revealed that £124m a week has been invested into UK funds this year as the popularity of sustainable and ethical investing continues to rise.

And, with more than £4 billion invested in so-called ESG funds so far in 2019, this trend is set to continue.

If you’re thinking of investing, you may be attracted by ethical funds. But what is ‘ESG investing’? How do ESG investments typically work? And are the returns comparable to other funds? Keep reading for answers to these questions and more.

What is ESG investing?

ESG investing is an attitude to investing that considers environmental, social and governance factors alongside financial factors in the investment decision-making process.

  • Environmental – how companies consider issues such as climate change and the impacts of their operations and products on the living world. More and more people want to know about the provenance of foods they purchase, whether products are tested on animals, if the manufacturing process contaminates the local rivers and so on.
  • Social – how a company operates in its community. This includes aspects such as working conditions, health and safety, salary equality and employee relations. Refusing fair holiday or sick pay rights, selling user data without permission, or overuse of plastic in product packaging might all be seen as social issues in varying guises.
  • Governance – how a company provides leadership. This considers executive pay, board diversity and issues such as bribery and corruption. Without good governance, the risks of investing in a company are significantly higher. A good example is the Volkswagen emissions scandal which could be attributed to governance failings.

While there are clear differences between all three areas, they are often interconnected. For example, BP’s Deepwater Horizon rig explosion and subsequent oil spill in the Gulf of Mexico had an impact in all three areas:

  • Environmental – the damage done to the ecosystems
  • Social – the employees killed, and the communities affected by the spill
  • Governance – management failings in the run-up to the disaster.

Why is the demand for ESG investing increasing?

There are many reasons why investors are increasingly turning to ESG funds:

  • Greater awareness of the effects of climate change
  • A greater focus on good corporate behaviour following the 2008 financial crisis
  • A high media profile for responsible investing
  • Evidence that good corporate sustainability performance is associated with good financial results
  • The opportunity for investors to ‘vote with their money’ and select companies and funds that align with their personal values.

How does ESG investing work?

There are several different ESG investing approaches that companies and fund managers take. Some of the most common are:

  • Negative screening – avoiding investing in companies based on their business or individual values, standards or norms. Companies could be excluded, for example, if a company is engaged in certain activities such as gambling, tobacco, alcohol, pornography, child labour or arms
  • Thematic investing – investing based on trends or structural shifts, such as social or industrial trends
  • ‘Best in class’ selection – preferring companies who have better ESG profiles than other organisations in their sector
  • Socially responsible investing – taking a values-based approach to investing, aiming to deliver a positive social impact
  • Positive screening – investing specifically in companies that deliver benefits to the community, for example through activities such as recycling, environmental technology, public transport and education
  • Faith-based investing – aligning investments with faith-based values. This often means avoiding companies whose business activities are seen as violating the teachings of a certain faith
  • Mission-related investing – aligning investments with organisational values or to further philanthropic goals. These investments often aim to generate measurable positive social or environmental impacts.

Will I get a good return by choosing ESG investments?

A longstanding criticism of ESG investments is that you don’t get as strong a return as you would with more ‘traditional’ investments.

However, recent research has found that ethical investments can provide equal, if not better, returns than their conventional counterparts.

Morningstar data from July 2019 showed that the top three performing ESG funds all gained more than 16% over a 12-month period.

In addition, all the ESG investments occupying the top ten places recorded double-digit growth in just one year.

Also, the types of companies who are financed by ESG investment funds often perform better. These companies typically have lower costs of capital and higher returns, as evidenced by the landmark study ESG and Corporate Financial Performance by Gunnar Friede, Timo Busch and Alexander Bassen.

And, while past performance is not necessarily a guide to future performance, research shows that the MSCI KLD 400 Social Index – focusing on 400 US firms which score highly in ESG terms – has outperformed the S&P 500 since 1990.

Get in touch

If you’re looking to invest, or you want to find out more about ESG investments, we can help. Email enquire@london-money.co.uk or call (0207) 808 4120 to find out more.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.