ESG investing: A beginner’s guide

What is ESG investing?

ESG Investing is a form of investing whereby alongside your returns, you can also have a positive impact on our world. This type of investing was borne out of the United Nation’s (UN) 15-year agenda which called on Governments and companies around the world to take transformative steps to build a better future for the population and our planet.

ESG investing is based on the UN’s 17 Sustainable Development Goals which are designed to tackle a wide range of economic, socio-political and environmental challenges that the world faces.

These 17 Goals have formed the framework for how corporations are adapting their businesses in order to benefit from both continued commercial successes, as well as satisfying investor demand for sustainable practices.

This has led to the creation of ESG funds which include companies within their portfolios that are succeeding in following the Sustainable Development goals. In theory, the more that companies excel in these areas, the more they will be included in ESG funds. The more they are included in ESG funds, the more investment they receive from institutional & retail investors which can help their future growth prospects.

What does ESG Investing actually stand for?

Environmental:
How environmentally friendly is the company? – this can be assessed by looking at the levels of greenhouse gas emissions, resource depletion and waste. 

Social:
How does the company manage relationships with its own people and the people it deals with? - For example, looking at employee relations, diversity in the boardroom and working conditions, but also the wellbeing of their customers and clients. 

Governance:
How well is the company run? - For example, looking at executive remuneration, shareholders rights and combating corruption and bribery.

Why is ESG Important? 

Society, as a whole, has become more aware of the world’s social and environmental issues and active investors are taking more of an interest in corporate governance and so are seeking sustainable investment solutions to help make a difference. 

Pure Ethical investing was historically seen as the pinnacle of sustainable investing using a process of ‘negatively screening’ companies which would eliminate those companies and funds that who don’t adhere to strict ethical standards. However, this restricted the investment universe & compromised potential returns.

ESG investing ‘positively screens’ companies that score well in any of the three categories, including the E, the S and/or the G, encouraging companies to follow best practices and simultaneously attract more investment as a result.

By following these best practices society tends to rewards those companies by allocating more capital or cash to support their growth as a business. This practice in turn alleviates pressure on the environment and improves social and corporate governance practices. As we’ve mentioned above  this generates a positive feedback loop with companies included in more ESG funds  attracting more investment.

What are the difficulties that ESG investing faces?

Assessing a company based on its ESG criteria is by nature subjective, as different people will have different opinions on what constitutes good practice. Moreover, lots of business practices are intertwined with other companies whose practices may not comply with ESG criteria. Take for example a Supermarket retailer who treats its employees well, doesn’t have excessive executive pay and adopts strict environmental policies regarding commercially produced waste. This would score well on all three ESG criteria. However, as a retailer, they sell tobacco products and some of their suppliers have fallen foul of child labor laws and pay their staff below minimum wage.

Would you exclude the supermarket on the basis they sell products you don’t agree should be sold? Or the fact they engage in business with companies who have a track record for the exact practices ESG investing is attempting to stop?

The point here, as we’ve said, is that ESG investing is subjective and while a company such as this retailer can score highly and be included in an ESG portfolio, that doesn’t always mean that everything the business does is run on ESG principles.  It can be down to perception and one person’s view may differ from another’s entirely.

Can I still have a well-diversified investment portfolio? 

Some opponents of ESG funds claim that investing in ESG does not lead to a well-diversified portfolio. Whilst this is strictly true, as more companies around the world adopt ESG practices, the range of well rated companies across global markets has dramatically increased. 

The rise in popularity of ESG funds has already started to create a positive feedback loop. In the first quarter of 2021, record demand to invest in sustainable investment funds saw the sector’s total assets rise 19% to a total of $2trillion in the first quarter. There were 169 new sustainable funds launched over the same period and global sustainable funds attracted a record inflow of $185.3 billion; a 17% increase in new cash being invested, compared to Q4 2020.

It is inevitable with negative screening that less companies will be open to an ESG portfolio, however the counter to this argument can be that you are also future proofing your portfolio. Companies with strong ESG profiles may be better positioned for future challenges and experience fewer instances of bribery, corruption and fraud. Most importantly there is of course the overpowering mantra that investing for “good” surely cannot be a “bad” thing. You can now access a wide range of funds across a range of asset classes and geographical locations to build a well-diversified portfolio of ESG investments and as it grows in popularity, as highlighted by the statistics above, you will only have more choice on offer.

Do I sacrifice performance in order to follow my values?

In the past, investors have avoided ESG investing due to a perceived negative impact on performance. However, in a study carried out by Morgan Stanley, between 2004 and 2018 there was no trade off in the returns of ESG funds compared to their more traditional counterparts. 

Is ESG more expensive?

There are those that believe that opting for ESG investments would increase the costs of investing and ultimately that cost will act as a drag on performance. Actively managed ESG funds have a similar cost to other actively, unrestricted, managed funds and the cost differentials are minimal.

How can you invest?

At Investment Champion, there are three products available: an Individual Savings Account, a General Investment account and a Self-Invested Personal Pension. Within these products, you can invest in Traditional & Sustainable (ESG) portfolios, with each Investment Champion portfolio designed to suit different people’s goals and risk appetite. To keep things simple, these are numbered 2-5 (Cautious to Adventurous).

You must decide how much risk you are willing and able to take. The sustainable portfolios incorporate Environmental, Social, and Governance (ESG) factors and are designed to be a long-term mix of equity and bond investments with some passive instruments included to keep costs low.

At the time of writing our ESG portfolios have seen positive returns so take look at our product pages or contact us to learn more about how to invest.

Please note: Past performance is no guarantee of future returns. The value of investments and the income from them can fall as well as rise, you may not get back what you originally invested.