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Are your investments more sustainable than you think?
If you haven't heard about the rise in ESG investing already you will undoubtedly do so soon, as more and more businesses and investors are getting on board with investing for good.
ESG is a form of investing whereby alongside your returns, you can also have positive impacts. Over recent years this approach to investing has risen in popularity, especially since the pandemic.
Society as a whole has become more aware of the world’s social and environmental issues and active investors take more interest in corporate governance. More investors are seeking sustainable investment solutions to help make a difference.
The ESG investment framework relies on a non-financial assessment of a Company based on three core principles:
E - Environmental – How environmentally friendly a company is. For example, looking at the levels of greenhouse gas emissions, resource depletion and waste.
S - Social – How a Company manages relationships with its people and the people it deals with. For example, looking at employee relations, diversity and working conditions but also the wellbeing of their customers and clients.
G - Governance – How a Company is run. For example, looking at Executive remuneration, corruption and bribery and Shareholder rights.
Many fund managers are now selecting companies which aim to support one or more of the 17 sustainable development goals that the United Nations has rolled out to support their 2030 agenda.
The Sustainable Development Goals are the blueprint to achieve a better and more sustainable future for all. They address the global challenges we face, including poverty, inequality, climate change, environmental degradation, peace and justice.
There are a number of ways to invest with an ESG mindset;
Negative screening – excluding companies.
Positive screening – investing in sustainable companies.
Impact investing – Helping businesses fund specific goals that are related to improving society, governance or the environment.
Philanthropy - Donating time, money, experience, skills or talent to help create a better world.
With so many labels used around ESG, it can be hard for investors to identify the best options. There is also the risk of investing in something that isn’t as ESG friendly as it may seem, this is known as greenwashing.
Greenwashing
One of the big concerns in the ESG space is greenwashing, which refers to companies and organisations claiming to be aligned with ESG objectives and principles, when they are not. This can be as simple as a business promoting a product, service or the company itself as being environmentally friendly/ sustainable, when on closer inspection this may not be wholly true.
Why are firms doing this?
In a nutshell, they do this to capitalise on the growing success that the ESG title brings with being truly engaged in being a positive/ sustainable company.
The problem is, there are so many different labels and jargon used in the ESG space it can be hard to fully understand what is truly a sustainable investment.
The Sustainable Finance Disclosure Regulation (SFDR)
Appearing more sustainable than you really are creates a landscape where investors are being misled or mis-sold products that fail to meet their needs. In an attempt to reduce greenwashing and make ESG clearer for investors, there has been new regulation in force in the European Union.
The Sustainable Finance Disclosure Regulation (SFDR) was introduced in March 2021. It enforces a requirement for Fund Managers to provide ESG related information when marketing products. What this means, is a fund cannot just say they are ESG, they have to prove it by publishing standardised material.
Green Taxonomy
As the UK is no longer part of the EU, it has not implemented the SFDR.
However, the UK is in the process of creating its own ‘Green Taxonomy’ and ESG disclosure requirements that will create a common ESG language to be used and understood by the masses. This means there will be a clear understanding of what ESG is, and what is means. This will equally be understood by everyone.
Rating ESG funds
When reviewing ESG funds, there are a number of ways to look at how they are structured- their ratings being one of them.
An ESG rating is a measure of how a company is performing in line with its ESG responsibilities. The ESG scores exists for external bodies and the company itself to review how it is perceived to be performing against others. To put this in perspective, investors believe that companies that are aligned to these goals are less risky and better prepared for the long term. ESG ratings are usually based upon a number of criteria, many of which may align with your own values and morals. While assessing non-financial performance, good ESG ratings can indicate that a company has strong staying power, through strong governance and is planning for the long term. As such, you can invest in companies that not only align with your values but are more likely to have a long-term future too.
There are a number of companies that provide ESG ratings and criteria. Some of the biggest agencies include Morningstar, MSCI, RobecoSAM, Sustainalytics and Vigeo Eiris. To see a full breakdown of how some of these agency’s rate ESG funds please visit the link below.
theprivateoffice.com/insights/how-are-esg-ratings-calculated
You could be more ESG than you realise
What is interesting now, is there are some investment funds that may not be ESG focused but are actually rated higher and scoring as high as ESG funds. So how could this be? A simple reason is traditional funds still look to invest in companies that are going to be around for the long term, and in the present day, to be successful in the long-term companies must make sure they are sustainable and can still appeal to the changing demands of consumers.
To support this, research from Barclays found that ESG funds are not really different from conventional funds in terms of holdings, risk exposures and therefore performance. This conclusion holds even for the subset of funds that changed their designation from non-ESG to ESG-focused. This could well be because there is still no standardised way to rate ESG funds, many struggle to establish what makes a fund better, more emphasis on the ‘E’ or on the ‘S’, or ‘G’.
There are many who believe that soon there will only be ESG investing as more companies realise the need to be sustainable, and those that don’t simply will cease to perform well. This also applies for funds, ESG funds survive longer than their traditional counter parts.
With the EU regulation in place and Green Taxonomy coming into place in the UK, there will be a more standardised assessment within the industry. As the popularity of ESG investing increases, regulation and labelling should lead to a clear way to identify what different funds are invested in, so that in turn, as a retail investor you can clearly see where your money is being invested.
It is important you engage with a professional adviser to ensure the appropriate investments are chosen from the outset, and are clearly aligned with your investment approach and views, especially when wishing to invest with an ESG mandate.
If you’d like to learn more about ESG investing and how this approach may suit your own personal investment goals, why not get in touch with one of our experts today for a free initial consultation. We also invite you to watch our webinar on the 16th November where will be discussing ESG in detail.
Please note: The value of your investments can go down as well as up, so you could get back less than you invested.
