Even if you’re not an investment guru, you may well have heard of ESG. More and more financial headlines are sporting this acronym and everyone seem to be talking about it. But what does it actually mean and is it relevant for you?
Like many other things in the world of investing, the first step is to unravel the acronym. ESG stands for Environmental, Social and Governance. These are three pillars that influence an investment style that aims to, for lack of a better term, make the world a better place (or at least a less bad one).
A lot of people have been choosing to invest this way recently, to a large extent because of growing concern about climate change. If this resonates with you then the easiest way to get into ESG investing is to invest in an ESG fund. But is it really that simple?
Labels, labels, labels
No, unfortunately it isn’t. There is a little more to it than just sticking your money in any fund that has ‘ESG’ on the label and forgetting about it. There are actually a number of different types of ESG funds and they all have a slightly different approach. But we promise it’s not as complicated as it may seem at first glance!
You may have heard or seen a few of these names: Sustainable/Responsible Investing, Socially Responsible Investing, Ethical Investing, Green and Impact Investing. At a high level, what sets these different styles apart is how proactive they are about making the world a better place. For now though, let’s agree to just call it ESG investing and we will dig into the different ‘flavours’ in more detail in later posts.
I’m the greenest of them all…
One way to think about ESG investing is as a sort of gradient going from light green to dark green, a philosophy devised by sustainable investing specialist, New Money[1].
On the light green side of the spectrum funds focus on excluding ‘bad’ companies from what is referred to as ‘sin’ industries. These include gambling, tobacco and weapons, etc and this method is commonly called ‘negative screening’. This type of fund is labelled ESG, Ethical or SRI.
As the spectrum gets darker green, so do the funds. The level of integration of ESG principles in the investment process becomes more intense, as does the objective of solving global issues. Often, these funds will be labelled Sustainable and they may have specific sustainability targets, such as the UN Sustainable Development Goals, which are more commonly known as UN SDGs (because finance folk clearly can’t help themselves from creating yet more acronyms).
The greenest of them all are Impact Funds. Ok, so maybe these guys won’t go on hunger strike, but only because they have better methods of pestering the businesses they invest in until they give up and change for the better. Or better yet, they may invest in companies that are proactive in making the world a better place, even without being pushed to do so. These funds tend to have pages and pages of reports to prove the effectiveness of their process, if you’re into that sort of thing.
But what about my returns?
For some investors, choosing an ESG fund is a way to make a stand against companies that are facilitating climate change, such as fossil fuel giants. But most of us still want to make money when we invest, not just take an ethical or environmental stand. So, the million-dollar question is, can we really have it all? Well, as you may have seen in amongst all the COVID news, ESG funds have performed rather well in this latest stock market crash, at times even better than other funds[2] (to be clear, they have lost less than other funds).
You may think ‘Wonderful! Where do I sign up?!’ But it’s important to also understand why this has been the case. ESG funds usually don’t invest in the oil industry, which has been one of the worst-performing sectors in the market. And to make things even better, they tend to invest more in the healthcare and technology sectors, been some of the strongest performing sectors. What all of this really means is that there is no silver bullet when it comes to investing, but you don’t necessarily have to sacrifice your ethics in order to target a good return on your savings.
That’s it for today – ESG investing in a nutshell. As you may have picked up, it’s not as Easy as it looks, it’s quite a Specialist area of investing, but if done right, ESG investing can do a lot of Good, beyond just your wallet!
[1] You can find a ‘green grid’ which illustrates this on page 4 of the The New Money Guide to Greenwashing, which can be downloaded here.
[2] As evidenced by research from Morningstar.
Date of publication: 18th June 2020
The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.
When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.