Why ESG is just one part of your investment decision

ESG investing doesn’t have to be an ‘all or nothing’ approach.

We’ve written before about the coronavirus pandemic re-focusing society’s view on sustainability for the better.

Increasingly many investors are choosing to consider non-financial factors when analysing growth potential. This has led to a switch towards Environmental, Social and Governance (ESG) funds.

This, and the likelihood that the ESG criteria will be integrated into all portfolio management in the future, have made the market for these funds soar in recent years.

Is ESG investing for me?

Investing into ESG funds is a proactive approach to investing. Fund managers with a sustainable investment mandate will target investment into those companies that have been identified as having a positive social and environmental impact. Not to be confused with a purely ethical investment style, which rules out firms in certain types of industries – such as mining or tobacco.

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One stigma surrounding investing into ESG funds comes from thinking that it is an “all or nothing” approach to investment. This is simply not the case. How much of your portfolio is invested in ESG investing is based on your wants and needs, just as it is with any other type of fund.

Just because you want to do the right thing by investing responsibly does not mean you have to invest all of your wealth doing so. All investing, whether ESG or not, is based on your attitude to risk and your preference - so taking a blended approach could ensure at least some of your money is invested responsibly but not all your eggs are in one more limited basket and any possible associated risks that come with that.

It is even possible to opt for more traditional funds that still have a moral and ethical agenda.

For those more adverse to risk who would prefer to focus on ESG funds, you can invest into bonds that fit the ESG criteria. These firms may offer lower volatility because they may be less likely to suffer from bad publicity that could negatively affect the value of the firm, and their ability to repay debtholders. 

Whether you prefer an active approach to the management of your money or a more passive style, an ESG approach can be incorporated.

ESG funds may be more favourable for an active investor as they are based around company reputation, environmental impact of the firm and such factors that can change at a moment’s notice, meaning that a more active approach may be preferred.

This being said, a passive investing style can still function with ESG funds. Passive, traditional investing can still exclude “bad” firms – such as those in the tobacco or firearms industries. Large and stable firms such as Microsoft and Proctor and Gamble are widely respected as sustainable firms to invest in.

This means it is possible to select funds from an index that are sustainable and have steady, respectable returns. In addition to this, the FTSE4Good Index Series was launched in 2001 and measures the performance of companies demonstrating strong ESG practices in the UK.

With indices like these becoming widely accepted, it is becoming more practical for all types of investor to consider ESG funds for their portfolios.

Won’t I have to sacrifice the performance of my funds when choosing to invest in ESG funds?

ESG investing is often assumed to create a trade-off between fund performance and sustainability, or ‘doing the right thing with your money’. According to a study by research company Morningstar, this is a misconception; ESG funds have actually outperformed the wider market in the long run.

To put this into context of 4,900 funds analysed in the research (20% of these being sustainable funds), on average 77.3% of sustainable funds available to investors 10 years ago are still around today, compared with just 46.4% of traditional funds.

This could be because ESG funds tend to be biased towards higher quality companies that are run better and operate with more sustainability and efficiency.

Furthermore, throughout the ongoing pandemic ESG funds have outperformed traditional funds.

The graph below shows the growth of ESG funds net cash flow over the last 10 years. From 2018 to 2019 there was an increase of nearly four times the yearly cash flow from $5.5 billion to $20.6 billion which clearly shows the confidence investors have in these funds to succeed and produce healthy returns, as well as the excellent performance of the funds themselves.

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Source: Morningstar 

How much choice is there when choosing between ESG funds?

Although these funds are currently performing well, there is a smaller pool of ESG funds to choose from, as the market is relatively small but growing at a fast pace. As the graph below shows, the amount of ESG funds available globally has nearly doubled from 2018 to 2019.

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Source: EPFR Global – Number of ESG funds available globally 

Most ESG funds are currently European focused, as Europe is the sustainable capital of the world.

The early development of ESG funds and investment has come from Europe. Scandinavian governments and their investors have been the driving force for the rest of the world to get behind sustainable investing.

There are international ESG funds available, although they are in short supply. In the US, ESG investing is starting to gain momentum as supporters of this sustainable style of investing have recognised that current areas of interest, such as funds that are combatting climate change, are making notable returns.

This has caused a surge of US investors to move their assets into ESG funds, which will cause many firms to re-evaluate their stance on sustainability and cause them to make changes to meet the ESG criteria and strive for higher ESG ratings.

How can we help? 

At TPO we have built a range of risk-adjusted portfolios, to suit different appetites for investment risk, where the fund managers have a mandate to invest in companies which support a sustainable future for us all. 

If you’d like to learn more about ESG investing and how it can benefit you why not get in touch and speak to one of our expert independent financial advisers who would be happy to help. 

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Please note: The contents of this article are for information purposes only and do not constitute individual advice. The value of an investment and income derived from them could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a guide to future return.