Environmental, Social and Governance (ESG) investing is an increasingly popular investment approach. With growing awareness of climate change, global responsibilities, and social issues, investing in companies which act responsibly and prioritise making the economy cleaner, safer and healthier is an important consideration for many investors.

ESG investing takes account of environmental, social and governance issues when building an investment portfolio. The key areas of consideration include:

  • Environmental challenges such as climate change, pollution, fracking, biodiversity, environmental management, waste and the use of natural resources including water, forestry and mining.
  • Social issues concerning human rights, labour standards, child labour, equal opportunities, food supply, obesity and slavery.
  • Governance considerations relating to company management, board structure, executive remuneration, bonuses, avoidance of bribery and corruption.

Other factors may include values-based or ethical concerns such as tobacco, armaments, pornography, alcohol, irresponsible marketing and animal welfare. Issues do change over time, and in recent years fracking, climate change and racial equality have grown in importance to investors.

Early approaches to ESG investing may have involved simply avoiding investments in controversial sectors, such as tobacco or armaments. Today, there is a much more sophisticated approach which considers sustainability issues and investment choice. As a result, investors who are keen to include ESG approaches expect to be able to select investments that match both their financial and ethical needs.

Types of ESG investing

There are four main areas of ESG investing:

  1. Responsible ownership and engagement: this approach encourages companies to improve their practices in areas where investors believe ESG related risks and/or opportunities could be managed better for the benefit of shareholders.
  • Avoidance or negative screening: this method avoids companies involved in activities that are ‘unacceptable’ or ‘unethical’. This typically works by grading companies based on a list of undesirable business practices.
  • Positive screening strategies: investments are directed towards companies that meet an investment manager or fund’s ‘positive’ ESG objectives. Funds may focus on single sector issues in a narrow range of industries or companies that achieve certain standards.
  • Impact investment strategies: this aims to generate specific beneficial social or environmental effects in addition to financial gains. Its purpose is to use money and investment capital for positive social results including renewable energy and sustainable agriculture.

Why consider ESG investing?

Many investors choose to consider ESG investing in order to ensure any investment decisions reflect personal beliefs and values. As a result, they choose to support companies who are making informed, responsible decisions which take into account their wider societal and global impact. In this way investors can achieve peace of mind that their investments are creating a positive effect.

How does ESG investing work?

The number of ESG issues a company  takes into account will help determine whether it offers a good fit in terms of ESG investing. Ultimately it is how those issues are dealt with, referred to as an ‘ESG approach’, which determines investment strategy. Fund managers take time to understand the company’s  ESG strategy; mainly the issues it considers and the approaches it applies to those issues. It is important to remember that ESG factors are not the only relevant aspects when it comes to this type of investing. Generic factors impact ESG funds too. Managers will consider asset type, the market capitalisation of the stocks held, geographic spread and timing, investment aims (eg growth or income), benchmarking decisions, fund manager skill and charging structures.

Investors contemplating an ESG approach should consider whether there are any social, ethical, environmental or religious issues which are important when it comes to making any investment decisions. If so, it’s likely investors will be asked some questions by their financial adviser to identify what types of ESG investments might be most appropriate given these ethical and financial needs and objectives.

This then helps to inform the process of selecting appropriate investment managers or funds. This can be complex as ESG investments consider a diverse range of environmental, social and governance issues and approaches. For example, most funds take environmental concerns into account; not just those that are environmentally themed. Additionally, most avoid significant exposure to tobacco, armaments and other negative selection criteria. It is therefore important to focus on the key features which are important to each investor.

Who is making ESG led investments?

ESG investment approaches are now embraced by clients across the world. With a much wider breadth of choice available, a growing cross-section of society is investing in ESG options as they provide the ability to invest in a way that suits each investor’s personal aims – namely wanting to make a difference on social or environmental issues as well as the potential for positive investment returns.

At The Fry Group, we have found that our clients are interested in responsible investing but have highly diverse goals. Ethically-minded investors cannot be seen as a homogenous group and ESG funds are extremely diverse so it’s important for each investor to select funds which meet their ESG aims and ensure that any financial objectives are met.

How do ESG investments perform financially?

There is also growing evidence of a positive link between good ESG practice and company performance, perhaps in no small part due to the extra analysis which takes place into ESG funds, and the work being taken to identify long-term trends. Companies which incorporate ESG themes are also likely to be more resilient to future changes given they have already made, or are in the process of making, the changes needed as regulation tightens and attitudes evolve.  

What is the current state of the ESG investing market?

In the past, ESG investing has been seen as a niche investment approach, for a relatively small number of people with specific requirements. This has changed significantly in recent years, with a growing awareness of environmental issues such as climate change and an increasing understanding of social issues and human rights. As a result, many people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.

Our ESG portfolios are designed to suit investors who are both financially motivated and driven by specific personal values, and we work with fund managers who recognise that the management of environmental, social and governance issues can positively impact business success and who will buy forward-looking companies that they believe have the potential to achieve positive investment returns.

If you are interested in considering your investment portfolio from an ESG perspective please contact your nearest office.

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