ESG investing, also sometimes referred to as “ethical” or “responsible” investing, has been one of the most talked-about investment topics in the past 18 months.
Social issues such as climate change have never been higher on the agenda, so it’s hardly surprising that investors are flocking to align their investments with positive social values.
In fact, according to FTAdviser, ESG investments accounted for 90% of investment fund inflows in July.
With this much money flowing into ESG funds, it begs the question: what can ESG investing offer to your investment portfolio?
Aligning your investments with your values
The point of ESG investing is to produce positive social change by providing investment funding to companies that seek to better the world. In turn, this allows investors to choose investments that suit their personal views and values.
As an acronym, ESG stands for “environmental, social, and governance”. These are the criteria that fund managers use to assess companies and their positive behaviour when deciding whether to include them in their ethical funds.
Environmental factors include the ways in which companies seek to combat climate change and contribute to the health of the planet. This could be through the product or service they produce, or via sustainable business operations.
For example, this category could include companies that manufacture solar panels or wind turbines. It could also include companies that have carbon-neutral pledges for the future, or that have made efforts to make their supply chain as sustainable as possible.
Social factors involve the ways in which businesses keep good social practices in their operations.
This could be ensuring good conditions for workers or the way in which a company positively engages with its local community.
Governance criteria focuses on the behaviour of a business at corporate level.
This could involve things such as inclusivity of minority groups at board level or having strong anti-corruption and transparency regulations.
Some ESG investments outperformed “traditional” choices
The fact that investors overwhelmingly backed ESG funds and investments in July is no anomaly. This performance actually is part of a far wider trend, with some funds outcompeting their traditional counterparts over periods of more than 10 years.
Figures from investment provider Morningstar published in the Guardian show that, over the past 10 years, sustainable funds invested in large global companies offered average annualised returns of 6.9%. Meanwhile, traditional funds returned just 6.3% a year.
This difference may be marginal, but it’s indicative of both the performance of sustainable companies, as well as retail investors’ appetite for ethical choices.
The trend has only been accelerated over the past year too, as climate change and Covid have seemingly pushed ethical investing to the forefront.
Over the course of 2020, the Investment Association found that UK savers put an average of almost £1 billion a month into responsible investment funds.
Performance matched this fervour, too. FTAdviser published results from Fidelity’s “Putting Sustainability to the Test” report, a study that ranked stocks on the fund house’s internal ESG rating scale.
It found that stocks at the top of the scale had outperformed those with lower rankings in every month from January to September 2020, except April.
When looking at ESG investing from a purely financial perspective, it’s likely that investors who took the plunge in aligning their investments with their values would have seen a greater return than on non-ESG funds over the past year.
No set definition of “ethical”
Naturally, as with any investment strategy, there are downsides. And, because ESG investing has a moral element, there are specific issues that come with the territory.
Specifically, this is the fact that “ethical” is entirely subjective. While managers use the ESG criteria to rank companies, there’s no set definition of what every single investor would consider ethical in each category.
A good example of this is investments in nuclear power.
Nuclear power could be considered “environmental” because it doesn’t involve burning fossil fuels. As a result, it’s a carbon-free way to produce power.
However, nuclear energy has infamously been the cause of many serious environmental issues, most notably the Chernobyl reactor meltdown.
Additionally, even if nuclear power is produced safely and properly, there still isn’t technology to dispose of nuclear waste in any other fashion than to stack it in barrels in warehouses.
While being environmentally friendly, nuclear might take up storage space and present a biohazard in a way that wouldn’t align with your values.
As a result, you’d need to check the entirety of a fund’s underlying investments to be sure that the companies they back are indeed “ethical” by your standards.
Increasing your exposure to ESG funds
All in all, it seems the continued enthusiasm for ESG investing means there’s still space for the sector to keep growing.
With climate change, social issues, and a desire for corporate responsibility becoming increasingly important, it’s possible that even the biggest companies will need to modify their behaviour so that they can be included in ethical funds, too.
Of course, it’s important to remember that past performance is never an indicator of what will happen in the future. Just because the funds saw strong growth over the past year doesn’t mean it will continue.
Make sure that any ethical investment you choose is part of a diversified portfolio with the right balance of risk that suits you and your financial goals.
Get in touch
If you’d like to find out how ESG investing could have a positive impact on your portfolio, please get in touch with us at Novus.
Email email@example.com or call 01423 870731 to speak to us.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.