Everything you need to know about environmental, social and governance (ESG) investing

Ethical investment is growing. But what is it? How does it work and what returns can you expect? Your guide to ethical investing.

Ethical investing – that is investment focused on environmental, social and governance factors – is on the rise.

With climate change and the effects of plastic pollution in the news, and the fallout from the corporate mismanagement that led to the 2008 financial crisis still keenly felt, investors are increasingly looking to funds that provide a moral and ethical boost alongside good returns.

The growth of ESG investment in recent years has been especially pronounced in Europe, with Bloomberg reporting that it is, ‘the biggest region for sustainable investors, up 11% from 2016.’

Figures from Morningstar, as reported by Investor Chronicle, indicate that ‘£4.5 billion has been invested in ESG funds’ in 2019.

But what is ESG investment? How does it work and what returns might you see?

What is ESG investing?

ESG investing considers environmental, social and governance factors, alongside ‘traditional’ financial ones. These factors include:

Environmental factors include a business’ response to issues like climate change, renewable energy usage, and pollution. Companies that understand their impact on the environment and work to mitigate negative effects will have more appeal for ESG investors.

If you are looking to invest ethically, social factors that might influence your decision include how good a company’s working conditions and wages are, and how involved they are in their community. Companies that have a diverse staff, who are treated well and paid proportionately, may tempt ESG investment.

Governance factors include whether or not a company’s internal practices are ethical. This could include the democratic appointment of shareholders, transparent accounting and legal business practices.

Company involvement in any of the below areas would likely prevent ESG investment:

1. Manufacturing or selling of arms and weapons
2. Worker/supply chain exploitation
3. Environmental negligence
4. Tobacco
5. Gambling

Why has ESG seen such growth?

Investors are increasingly aware of issues around the environment, equality, and the need for responsible company management.

From David Attenborough and Greta Thunberg to Extinction Rebellion, climate change is never far from the headlines and businesses are increasingly feeling the pressure to present themselves as environmentally aware.

Elsewhere, the gender pay gap – most publicly at the BBC – and the continued fallout from the 2008 financial crisis, have given investors increased awareness of ethical issues. And with the freedom to choose, investors who have the option to ‘vote with their money’ are increasingly looking to ESG investment.

How does it work?

There are different approaches to ESG investing and those used differ between companies and fund managers.

Here are some of the most common approaches:

• Negative screening – this involves not investing in companies engaged in certain activities, for example, gambling, tobacco or alcohol
• Positive screening – seeking out companies that provide a benefit to their communities, whether through the environment, technology, or education
• ‘Best in class’ selection – picking a company to invest in based on their ESG performance relative to other companies in the same sector
• Thematic investing – investing based on social or industrial trends and the companies best placed to benefit from changing attitudes and practices
• Faith-based investing – this would mean avoiding companies whose business activities are seen to contravene the teachings of a particular faith.

Will I see a good return?

Being socially responsible with your investments doesn’t mean having to compromise on returns.

Recent research by Morningstar found that ‘41 out of 56 of their ESG indexes have outperformed their non-ESG equivalents (73%) since inception’.

The Triodos Global Equities Impact Fund has returned ‘78.3% over five years… £10,000 invested in the fund in September 2014 would have been worth £17,830 in September 2019’.

According to This is Money, ‘the FTSE4Good UK index beat the FTSE All-Share Index, returning 43% versus 42.5% over five years to 28 September 2018.’ In the US, comparative returns over the same period were even better: ‘the FTSE4Good US Index returned 155% compared to 129% for the S&P 500.’

The continued growth of ESG

Ethical investment is an area that is growing rapidly, and many experts predict that this growth will continue.

Investors are becoming increasingly aware of ethical issues and are keen to express their passions through their investments – more than half of millennial investors (52%) are already investing sustainably, according to FTAdviser.

And with sustainable funds matching, and in some cases outstripping the returns of their non-ESG equivalents, you can invest ethically and still see large investment returns.

If you’d like to discuss any aspect of ethical investment, please contact us.

The value of your investment can go down as well as up and you may not get back the full amount invested. Potential investors should be aware that past performance is not an indication of future performance.