TAKING an ESG approach to investing is worthwhile if you want your ISAs and pensions to back businesses that want to do the right thing. Crucially it can also make you a decent return.
The ESG acronym is short for environmental, social and governance, and is generally taken to mean how funds consider those factors in investment decision-making. Companies rated highly on ESG factors outperformed weaker counterparts in the first nine months of 2020, according to analysis by Fidelity International.
The only exception was the month of April, it said. The report showed that of the 2,660 stocks it reviewed, those with the lowest ratings lost 23% in the nine months to September while those with the top ratings saw a positive return of 0.4%.
Another report, The Good Investment Review by 3D Investing, analysed performance of almost 300 responsible funds. Over five years, the average responsible UK Equity fund returned 25.76% v a return of 16.52% from the IA UK All Companies sector. The average responsible Global Equity fund returned 82.53% compared with of 76.12% from the IA Global sector, over five years.
ESG investing has boomed in popularity in recent years. Fears over the many threats to our environment including climate change have led investors to favour companies and funds that support positive change. More recently, the pandemic appears to have reinforced the impact on society made by the behaviour of companies and organisations.
A survey by Aviva of 500 people found that half said the pandemic had made it more likely that they would take ethical factors into consideration when they invested. Indeed, Calastone, a funds network, said that UK investors ploughed a net £588m into ESG equity funds in September — a new record.
How to invest sustainably and ethically
If you haven’t already reviewed your portfolio to see how you can support companies and funds that take a strong approach to ESG, how do you get started?
How funds invest
First, make sure you understand the sector and different types of approaches to investing for good as there are many different definitions that can get muddled. Some funds will profess to be ESG funds, analysing stocks for their adherence to ESG, while others will aim to exclude certain industries that do harm, such as tobacco companies or fossil fuels.
Those that claim to be ‘responsible’ will consider the operational practices of the companies in which they invest looking for those that illustrate ‘best practice’ in their respective industries.
Sustainable solutions, meanwhile, seek to invest in companies that are providing solutions to social and environmental challenges in the hope of long-term financial benefits.
Impact investing is where money is used to make a measurable positive social or environmental impact.
While excluding seemingly companies behaving badly might sound like the right thing to do, there’s a valuable benefit for fund managers to stay invested.
A big part of active fund management is engagement. As huge shareholders, fund managers can engage with these firms to work with them to change their ways.
Finding the right funds
You can find information on ESG, responsible, sustainable and impact funds on your platform’s website. There’s no universal kitemark for a truly ‘good’ or ‘impactful’ fund. But some platforms have introduced responsible investment ratings which can help investors find the right fund. Ratings offer some guidance on how much good your money will do, or how closely the fund sticks to its promise to invest responsibly.
Interactive Investor, the UK’s second largest retail investment platform, launched ‘ACE 30’ in 2019 – its best-in-class list of ethical funds, ETFs and investment trusts. It has recently been boosted to the ACE 40 with 10 new funds added.
The Big Exchange is a new DIY platform supported by the Big Issue that only offers funds that have a social or environmental impact. Read our review here.
Elsewhere, EQi (previously Equiniti) displays ratings by independent research firm Square Mile, (instead of ratings compiled in-house) according to how funds take into account ESG factors.
Roboadviser Nutmeg offers a range of socially responsible portfolios, and ESG scoring for all Nutmeg portfolios. Each category is scored from 0-10, where a higher score signifies better adherence. Nutmeg this week reported that these portfolios are the fastest growing investment style in the business.
Nutmeg isn’t the only robo with ethical investments, there is also EQ Investors, Wealthsimple, Plum, Tickr and Wealthify to choose from.
ESG has become a powerful marketing tool and so hidden among the genuine ESG investments lurk ploys that use ESG to sugar-coat bad practice — a practice known as ‘greenwashing’.
It’s a must to check under the bonnet of these funds to make a call on whether they really do what they say on the tin. All investors should find out what is in a fund’s portfolio. For ESG investing, seeing a full list of holdings is the only way to check exactly where your money is going.
Equally, there is a great deal of ambiguity and inconsistency in how responsible investment terminology is used and understood so it’s important to drill down to the details of how your money is invested, rather than just relying on the name of the fund.
The Investment Association has recently published guidance for fund companies which aims to bring clarity and consistency to investors on the approaches they take to responsible investment.
Rishi Sunak, the chancellor of the exchequer, said the government would issue its first ever green gilt next year to ‘meet growing investor demand’. He said it would be the first in a series of new issuances.
Money raised by the bonds will be used to help fund projects to tackle climate change, build infrastructure investment and create ‘green jobs’ across the UK.
When launched, if the bonds are available to retail investors – and can offer a more attractive rate than deposit accounts — they could prove a hit.