ESG investing
Important - The value of investments can fall as well as rise, so you could get back less than you invest, especially over the short term. The information shown is not personal advice. You should seek advice if you’re not sure an investment is right for you.
What is ESG investing?
ESG is an investment approach where investors consider Environmental, Social and Governance factors as part of their wider research. They might think about issues like whether the company effectively manages its carbon emissions, whether it treats its customers, staff and suppliers well, and whether senior managers are incentivised appropriately.
Why consider ESG factors?
Taking ESG factors into account when you invest can help to avoid issues later. For example, a mining company might be less likely to face bad press if they have robust environmental and safety policies in place. And it’ll be less likely to face industrial action if it treats its workers fairly. Issues related to the way a company is managed, or its effect on the environment and society can cause reputational damage, impact profits and drag down a company’s share price.
ESG isn’t just about risk though. It can help highlight opportunities too. For example, if a company is making more progress reducing carbon emissions than most of the other companies in its industry, but this isn’t being reflected in its share price, the company could be an interesting investment opportunity, providing the rest of your analysis stacks up.
ESG terms explained
ESG – what’s the evidence?
There’s ever increasing research that suggests a link between companies taking ESG seriously and their corporate financial performance.
A 2012 Deutsche Bank study combined the results of over 160 academic studies, research papers and literature reviews. All of the papers they looked at suggested that companies taking ESG seriously tend to benefit from a lower cost of capital – i.e. investors perceive them as lower risk.
- 85% of the papers they looked at suggested good management of ESG issues leads to better corporate financial performance
- 89% of the papers demonstrated a positive link between ESG and stock market performance
However the study also noted that investors weren’t always good at capturing that outperformance.
Other more recent studies have suggested that the stock market is now better at pricing ESG information into share prices. This makes it harder for investors to use ESG analysis to gain an advantage over others. It’s still important to carry out ESG research though. If you don’t it could lead to investors undervaluing companies with strong ESG credentials, and overvaluing those that take ESG less seriously.
There’s also evidence that engaging with companies on ESG issues adds value. For example, a study of investor activity in the extractive sector showed a 4.4% additional return from companies that engaged with shareholders. They also tended to be less volatile than their peers.
It’s tough for individual investors to engage with companies. But when you invest in a fund, you leave that responsibility to a fund manager. They often have a pretty big stake in companies which means they can make sure their voices are heard on issues they think will benefit investors.
How can you mix in ESG into your share portfolio?
ESG is just good risk management. Just as an investor should be aware of a company’s competitors, amongst other things, they should also understand the environmental, social and governance risks that could impact a business. There are a number of ESG factors that investors could consider. We’ve listed some of them below.
You can get this information from a number of sources, including the ESG disclosures in a company’s financial reports and its website.
You might not be able to answer every one of the questions for every company you think about investing in, and very few companies will score ‘full marks’. Just because a company falls short on a couple of measures, it isn’t necessarily a bad investment. But it’s something to consider when building your investment case.
It’s also worth remembering that the importance of these questions depends on which sector a given company operates in. For example, water restrictions would have a much greater impact on companies that need clean water to make their products, like those in the food and drinks industry. On the flipside, water restrictions wouldn’t have much impact on a company involved in financial services. For these companies, fair marketing and advertising practices are a greater concern.
What if I want to invest in ESG funds?
When you invest in a fund, you leave the responsibility of company research to a fund manager.
Fund managers are increasingly recognising the value of ESG and most mainstream managers are integrating ESG into their investment processes in one way or another.
If you want to find out how a fund manager approaches ESG, you can start by checking the fund documents, such as the factsheet. A fund manager’s website can also be a useful resource for ESG-related information.
But if you want to be more proactive in your approach, you could go a step further and consider investing a portion of your portfolio in a responsible investment fund. We look at three below. All of them engage with the companies they invest in to push positive change, in the interests of investors. This is not personal advice or a recommendation to invest. If you’re not sure if an investment is right for you, please seek advice. Investments rise and fall in value, so you could get back less than you invest.
Each of the following funds take a different approach to responsible investing. You should carry out your own research to make sure responsible funds invest in a way that’s in line with your attitude to risk and personal ethics. These should be held as part of a diversified portfolio and they won’t be suitable for all investors. You should understand the specific risks of a fund before investing. For more information, please refer to the Key Investor Information for each fund.
Aegon Ethical Equity
- The Aegon Ethical Equity fund has been managed by Audrey Ryan for more than two decades. She aims to identify and understand the key environmental, social and governance risks of each company, industry and sector she invests in. She believes companies that lead the way in governance and sustainability tend to outperform over the long run.
- Ryan uses a strict approach and excludes certain areas completely. She won’t invest in companies involved in activities deemed unethical, from tobacco and alcohol producers, to munitions manufacturers and companies that use animal testing.
More than two thirds of the UK’s largest companies are excluded from the fund’s investment universe for ethical reasons. This means there’s a focus on higher-risk small and medium-sized companies.
Please note this fund currently holds shares in Hargreaves Lansdown PLC.
Legal & General Future World ESG Developed Index
- We think the Legal & General Future World ESG Developed Index is a good option for broad exposure to global stock markets, while being mindful of ESG issues. It invests in over 1400 companies across the globe and aims to track the Solactive L&G ESG Developed Markets Index.
- The index increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay. It also reduces exposure to companies that score poorly on these measures.
- The fund won’t invest in tobacco companies, pure coal producers, makers of controversial weapons (such as cluster munitions, anti-personnel mines and chemical and biological weapons) or persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption).
- Legal & General has been managing tracker funds for more than three decades and is home to the biggest index tracker team in the UK. That means it’s got the resources and expertise to track indices as closely as possible. The managers’ flexibility to invest in derivatives adds risk though.
BNY Mellon Sustainable Real Return
- The BNY Mellon Sustainable Real Return fund is a more conservative option for investing responsibly. Launched in April 2018, the fund follows the same robust investment process, implemented by the same team, as the BNY Mellon Real Return Fund.
- The team aims to make money in a variety of market conditions. The fund’s ‘return-seeking core’ accounts for around 80% and invests mainly in the shares and bonds of well-run, financially secure companies. They think these companies have a unique set of advantages over their competitors. They also consider how well those companies manage their impact on the environment and society. The rest of the portfolio is invested in government bonds, commodities and cash, with the aim to dampen volatility.
- The fund’s sustainable ‘red lines’ ensure companies that violate the UN Global Compact Principles and those incompatible with the aim of limiting global warming to 2°C aren’t considered. It also won’t invest in any company that makes more than 10% of its revenues from tobacco.
- The managers’ flexibility to invest in high-yield bonds, emerging markets and derivatives adds risk.