Environmental, Social and Governance (ESG): Is the Grass Always Greener?
Sustainable. Green. Ethical. ESG. There are many different names attached to responsible investments and it can be difficult to understand what’s going on under the bonnet and what their benefits and downsides are. This article seeks to give a brief overview of these areas.
What is ESG?
ESG stands for Environmental, Social and Governance- three broad areas which represent interests of responsible investors. Examples of what they encompass are:
Environmental – climate change, polluters, deforestation, poaching
Social – workers’ and human rights, data protection, slavery, diversity
Governance – accounting structures, corporate governance, anti-money laundering
What are the main ESG strategies?
Each responsible fund will have its own individual investment strategy and focus. Some can be broad with their proposition (e.g. an index tracker which has screened the index and removed non-responsible companies) whereas others can be very specific (e.g. sustainable water and waste).
As a starting point for choosing which underlying investments to hold, funds will use either ‘positive’ or ‘negative’ Selection. The former selects themes the fund wants to support, whereas the latter focuses on avoiding investments the fund deems to be irresponsible.
On top of the above selection strategies, there are different ‘shades’ of green. At one end of the scale, there are ‘dark green’ funds for which their primary ambition is making a real positive impact in the world. To this end, they often have very rigorous due diligence and research procedures and strict criteria for the investments they select to ensure their objectives can be met. On the other end, there are ‘light green’ funds that focus more on an alignment of values rather than real-world change.
There is no right or wrong way to create responsible funds and the decision as to which responsible funds to incorporate into a portfolio will depend entirely on the investor’s objectives.
What are the benefits of ESG Investing?
The headline benefit of investing in ESG funds is that they give the investor the potential for capital growth whilst either making an active positive difference or limiting the extent to which their investment funds are‘ big nasties’. In essence, they allow investors to take more agency over how their money is appropriated and the subsequent impact it may have on the environment and society.
From a performance perspective, the ESG space is one that is fast growing and companies which align with its values are likely to be receiving more funding than other less progressive areas. Furthermore, a well governed company run in a sustainable way will be ultimately more likely to provide more resilient returns which will, in turn, be passed on to shareholders.
Additionally, if an investor already holds ‘unconstrained’ funds (i.e. funds that aren’t restricted in the areas they invest in), adding responsible funds to their portfolio serves as a way to help diversify and therefore reduce the overall volatility of the range of investments held is increased within any investment wrapper (e.g. ISAs, pensions, bonds, general investment accounts).
What are the downsides?
One of the main criticisms of ESG funds is that it can be difficult to tell if a fund is truly responsible, or if it is trying to capitalise on tenuous or circumstantial alignments to ESG values. It is hoped that, as the ESG space develops, the criteria for what constitutes a responsible investment will be clearer cut and funds will have to be more transparent about the metrics they have relied on to be able to call themselves ‘responsible’.
Unsurprisingly, the enhanced research and due diligence conducted by fund managers when creating responsible funds requires time and resources which come at a cost that is passed on to the investor in the form of typically higher fund charges compared to unconstrained funds.
Finally, as ESG funds by their nature focus on a limited number of sectors and tend to be weighted towards high-growth areas, the capacity to diversify is reduced. As a result, ESG investments tend to be more volatile than other investments. However, as mentioned above, this can be countered by incorporating a range of other investments into the investor’s portfolio.
There is no ‘one size fits all’ approach when it comes to investing and, like all other strategies, ESG investing has its own merits and pitfalls.
Where we invest has an influence on how the wider world is shaped and there now exists an arena of responsible investments which have taken up the mantle in helping our money shape the wider world for the better. In addition to the moral principles of responsible investing, there are clear quantifiable monetary benefits to incorporating ESG investments into a portfolio.
So, whether you’re an altruist, capitalist or opportunist, the ESG investment space is an exciting and rewarding one to be a part of and is not to be dismissed!
If you would like to find out more about responsible investment opportunities please contact Kreston Reeves Financial Planning, part of the Craven Street Wealth group on +44 (0)330 124 1399, or complete our online enquiry form.
The content of this article is for information only and does not constitute formal financial advice.
This material is for general information only and does not constitute investment, tax, legal or other forms of advice.
You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.
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