Environmental, social and governance (ESG) criteria refers to a set of factors that investors use to determine potential investments.
In recent years, they have received a large upturn in popularity. Recent research carried out by Morningstar found that £124m per week was being invested into UK ESG funds during 2019, with over £4.4bn invested over the course of the year before October.
Investing in ESG funds is a great way to align your investments with your own moral values. But what actually are ESG funds? Are they viable for investment? Let’s take a look…
What is ESG investing?
ESG investing focuses on three areas:
- Environmental – this refers to whether companies consider issues such as unsustainable deforestation and climate change. It could also include whether the company’s products are tested on animals or whether the manufacturing process contaminates local water supplies.
- Social – this refers to how the company serves its community. Does the firm sell user data without permission? Are there fair holidays and sick pay rights? This may also include factors such as working conditions, health and safety, employee relations and equality in the workplace.
- Governance – this relates to factors such as executive pay, bribery and corruption. Governance is all about the leadership of the companies you invest in: if they have bad governance, the risk for your investment could be higher. Think of Uber culture scandal or the Volkswagen emissions scandal.
How does it work?
There are a few ways that ESG investing can be approached and it will vary between companies and fund managers. They may invest based on social and industrial trends. Another approach, called negative screening, leads to fund managers avoiding companies based on their values or standards. This might involve them excluding alcohol, arms, child labour, tobacco or alcohol. On the other hand, positive screening is where investments are only made in companies that deliver benefits to the community, such as environmental protection, public transport or education.
The fund or firm may want to align their investments with certain philanthropic goals, or they may want to target companies that have the best ESG profile within a certain sector. In the end, it’s good to do your research, so you can get an idea of what their ESG policies are.
Why is it so popular?
Data from Morningstar showed that there was a 2,500 per cent increase in investment between 2014 and 2019, which poses the question: why are investors increasingly turning towards ESG funds? The most common reasons for this were:
- There’s a higher media profile for responsible investing
- After the 2008 financial crisis, there is greater focus on positive corporate behaviour
- Being able to vote with your wallet, meaning that investors can select companies and funds that align with their personal values
- Overall greater awareness of the impacts of climate change
- Evidence that corporate sustainability performance can lead to positive financial results
What do returns look like?
It’s often thought that with ESG funds, you’ll be sacrificing stronger returns by aligning your investments with your moral compass. However, research carried out by Morningstar back in July 2019 found that the top three performing ESG funds all gained more than 16% over a 12-month period. Further to this, all the top ten ESG funds recorded growth in double digits in just one year.
However, it’s important to remember that although these funds have seen positive performance during the last year, it’s no indication of future returns.
At Advisa Wealth, we support those who want to get involved in ESG investing. We have a range of portfolios to help you invest from an ESG/Ethical standpoint while taking full account of your risk attitude and broader objectives If you would like details of these or have any questions, don’t hesitate to get in contact.