ESG investing is becoming hugely popular. But are environmental, social and governance ethical companies really going to make you profit?
ESG is an acronym for environmental, social and governance, all issues that people are seriously considering when choosing where to invest. ESG is a way of evaluating a company’s environmental and social impact that represents a set of positive social outcomes, against which a business or an investment can be measured. It evaluates everything from how sustainable the company’s energy use is to if they test on animals.
This interest in socially conscious investing has grown from the general public and into how businesses are run. This trend is something investors cannot ignore. Annual ESG fund flows in Europe increased from £45 billion to around £108 billion from 2018 to 2019. You may think with Covid-19 taking the limelight in 2020 the demand for environmental and social problems was overlooked. On the contrary, the pandemic has highlighted how environmental and social problems cannot be solved by individual government policies. Businesses and the financial sector have a responsibility to make positive change too.
What counts as ESG investing?
ESG investing covers any investment that has a positive social impact. A company is judged against an ESG criteria to screen how ethical the investment is. Certain companies are blacklisted, for example those that work with tobacco, gambling or arms.
The idea is that those companies that practice strong ethics are determined to make better investments as they are contributing to a positive social outcome.
Does ESG investing make bigger profits?
When people invest, they do it to protect and grow their wealth so ESG has to at least match other investment opportunities to get investors interested. Sadly, money still takes the number one spot on the priority list of most investors.
In the past there has been a perceived performance trade-off but is something of a fallacy today. One research paper on ESG investing found that, in the first four months of 2020, “more than 70% of funds focused on ESG investments outperformed their counterparts.” Similarly, “nearly 60% of ESG funds outperformed the wider market over the past decade.” Although ESG is not a concrete win win it is certainly turning the tables to outperform traditional investment options.
What issues come with ESG investing?
One of the biggest problems is determining the ESG definition. What counts as sustainable, green, or ethical enough? Funds try to include these buzzwords to encourage more investors but you should really do your research to check these companies aren’t pulling the wool over your eyes. Money’s report found that only 35% of people feel confident defining ‘sustainable’, while only 18% felt confident with ‘ESG’.
Thee has been moves to overcome this, like the standardisation drive led by the Investment Association. In November 2019, it launched a responsible investment framework that aimed to standardise terms like ‘ESG integration’, ‘sustainability focus’ and ‘impact investing’.
Top Performers
Royal London’s Sustainable Leaders fund was the top performing UK ethical fund over the past 10 years giving an almost 200% return, according to AJ Bell.
Investing in the UK has to be done carefully. The FTSE 100 is heavily dominated to the enrtgy sector that has less than ethical values.
“It’s a concentrated index and the biggest firms are massive oil companies,” says Jack Turner, investment manager at 7IM. “When you remove BP (BP.), Royal Dutch Shell (RDSB) and Diageo (DGE) you quite quickly build up a strong tracking error without taking a view.”
The bottom line is that ESG is something investors will increasingly consider making a part of their portfolio. From both an ethical and a growth standpoint, the development of socially and environmentally responsible investing is encouraging, making it increasingly difficult to ignore. If you’re ready to invest, we recommend eToro and easyMarkets for beginners.
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