Environmental, Social and Governance (ESG) investing has become an increasingly important focus for many of our clients.
There has been a substantial rise in the popularity of sustainable and ethical investments in recent years, driven by an increasing desire for investors to know where and how their money is being invested.
However, while these products have now become an established part of the mainstream investment landscape, many people remain confused about the terminology associated with this type of investing and are often unsure as to how to get started.
What is ESG investing?
ESG investing involves considering environmental, social and governance factors alongside financial considerations when assessing investment opportunities. When investment managers are deciding which companies to invest in, they may seek out and include companies based on their ESG characteristics.
Environmental factors refer to how companies are performing in their stewardship of the environment, for example:
- Carbon footprint
- Energy consumption
- Greenhouse gas emissions
Social factors consider how companies manage relationships with employees, suppliers, customers, and the areas where they operate, for example:
- Human rights and social justice
- Working conditions and employee relations
- Health and safety standards
Governance factors focus on company leadership, for example:
- Board diversity, structure and pay
- Avoidance of bribery and corruption
- Management & culture
ESG investing offers the potential to invest in ways that reflect the values that are important to you through using investment solutions that aim to take related ESG characteristics into account.
However, with investment managers and funds using varying terms such as Ethical, Sustainable, Socially Responsible, Impact Investing or simply Green, it can be difficult for clients to really understand what these labels truly mean and how they translate into an investment strategy that matches their personal views and reflects the values that are most important to them.
One of the most well-known terms is Ethical Investing. This involves actively avoiding those types of firms or industry sectors which are considered to have a negative impact on the environment or society. This approach is also known as ‘negative screening’ as it involves filtering out specific types of investment based on a series of ethical or moral judgements.
For instance, negative screening may exclude all gas and oil companies regardless of whether a firm operating in the sector generates any form of green energy. Other types of excluded ‘sin stocks’ typically include the likes of alcohol companies, tobacco producers, weapons manufacturers, the gambling industry and firms involved in animal testing.
Sustainable Investing uses ESG principles to actively select those companies that have a positive impact on the world, often in line with the United Nations Global Goals for Sustainable Development. This approach is therefore less restrictive than ethical investing as it allows for the fact that organisations are typically not either all good or all bad.
For example, under a sustainable investment strategy, a fund manager would be allowed to invest in an oil company that was developing clean, renewable energy sources.
Socially Responsible Investing (SRI)
SRI is one of the oldest ethical investment strategies, which involves focusing on a range of socially conscious themes such as employment rights, awareness of LGBTQ factors, social justice and corporate ethics.
This involves using an investment strategy which targets those companies that have a positive social and/or environmental impact whilst demonstrating high levels of accountability and governance.
Green Investing involves a strategy of selecting companies considered to be positive for the environment, such as those offering alternative sources of energy or those with a proven track record in reducing their environmental impact.
Are ESG funds higher risk?
There was often a perception in the early days of ESG investing that investors were putting principles before profit, with ethical or green investments generally considered to be significantly riskier than their traditional counterparts. Nowadays, however, with more and more companies adopting ESG principles within their corporate and social governance policies, there is a much wider choice of stocks available to ethical and sustainable investors, and so this style of investing can provide a compelling investment opportunity capable of generating long-term stable and sustainable returns.
Our bespoke planning process
Building a strategy around your personal core beliefs aimed at delivering financial success is central to our planning process.
One of the challenges with ESG investing is that it’s highly subjective; whilst you may want to prioritise the social impact companies can have, others may be more concerned about the environmental effects. It’s worth spending some time thinking about what is most important to you.
At Tees, as your independent financial adviser, we will work with you and take the time to truly understand your values including any ‘red lines’ you may have and where you may be willing to compromise. We take account of your financial aspirations and plan for how these can be delivered via an ESG investment strategy, that is tailored to you, so that you can feel comfortable with the investment decisions you are making.
We will also seek to understand the balance between your views and overall financial performance, as well as what impact you want your investment to have - i.e: to ‘do no harm’, or to ‘do good’.
'Do no harm’ or ‘do good’
Seeking to invest in companies that promote ESG values that are important to you is referred to as positive screening, as you look to ‘do good’. This may mean actively looking for opportunities in certain sectors or even dedicating a portion of your portfolio to this area.
Let’s say climate change and fossil fuel use is something you want to reflect in your investments. A negative, or ‘do no harm’ screening process may mean cutting out firms that are involved in the fossil fuel industry. In contrast, a positive ‘do good’ screening method could mean diverting a portion of your portfolio towards companies that are focused on renewable energy.
When looking to build an ESG investment strategy, it’s important to bear in mind that there often needs to be compromise, rather than trying to find a portfolio which exactly matches a particular set of ethical values. There is no such thing as 100% good or bad.
Ongoing monitoring of investment managers and performance
We continually monitor the investment managers that we recommend, and hold them to account to ensure that their investment strategies remain in line with the policies and beliefs for which their investments were selected on your behalf.
Monitoring and engaging with investment managers encourages good behaviour and is the best way to ensure they are practising what they are preaching.
We will also look to benchmark an investment manager’s performance comparative to their peers as well as assess performance against mainstream funds. There may be times when an ESG portfolio underperforms compared to traditional investments, as certain stocks (and indeed, whole sectors) can move in and out of favour during periods of economic and political stability.
We will look to focus on your overarching investment goals to ensure that we maximise your investment returns whilst continuing to invest in companies that work hard to manage their legacy and impact on the world.
There’s a great deal to consider when assessing ESG investment opportunities. Our clients tell us that taking professional independent financial advice from Tees, helps them to invest their money more in line with their core values and beliefs.
If you would like to find out more about our services, either speak to your Tees financial adviser directly, call our team on 0800 013 1165, or fill out our enquiry form and we’ll be in touch.
This material is intended to be for information purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Past performance is not a reliable indicator of future returns and all investments involve risks including the risk of possible loss of capital. Some information quoted was obtained from external sources we consider to be reliable.
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Chat to the Author, James Appleby
Managing Director, Wealth Management, Bishop's Stortford officeMeet James