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3 things you need to know about ESG investing

Investment Analyst Dominic Rowles talks about the trend towards environmental, social and governance (ESG) concerns and shares three key points you need to know.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

ESG is an investment approach where fund managers consider Environmental, Social and Governance factors as part of their wider research. Its popularity has risen rapidly in recent years and unlike some investment trends, it isn't going away anytime soon.

Governments are now paying more attention to the impact that issues like climate change, bad treatment of the workforce and poor executive behaviour can have. Here in the UK there are new rules to encourage pension fund trustees to think about these issues – they’re too important to ignore, and more legislation is expected.

But investing with ESG in mind sometimes gets a bad name for potentially holding back investment returns. With that in mind, we're busting the myths and highlighting three ESG truths you need to know.

This article and the information provided are not personal advice. If unsure, seek advice. Please remember that all investments rise and fall in value, so you could get back less than you invest.

1. Most mainstream fund managers are thinking about ESG in one way or another

Fund managers and fund management companies are increasingly recognising environmental, social and governance factors as genuine risks to the long-term success of the businesses they invest in. More and more are building ESG considerations into their existing investment process as part of their everyday risk analysis.

They're doing it at different rates and some are doing a better job than others, but they're almost all thinking about it. Before investing in a company, fund managers consider the threats to that business – its competitors, growth-restricting regulation, and any potential fines that could impair profits. ESG investing is part of this process.

2. 'Sin stocks' such as alcohol and tobacco aren't necessarily excluded

Fund managers approach ESG in a number of different ways. While some may choose to exclude morally questionable companies, such as alcohol or tobacco companies, others prefer not to restrict their investment universe.

They'll always consider the environmental, social and governance risks associated with a business. But if they feel those risks are accounted for by the company's low valuation, some fund managers may still choose to invest.

Some managers might also invest if a company is saying it wants to improve. For example, they might invest in an energy company that makes money from coal mining if the company has committed to reducing the size of its fossil fuel business over time.

Every investor has a unique set of ethics and beliefs. What feels acceptable to one might seem morally wrong to another. That's why it’s important to do your own research and make sure you're happy with a manager's approach before you invest.

3. ESG can boost performance

A number of studies have shown that companies taking ESG seriously tend to outperform those with a more relaxed attitude towards it. That shouldn’t come as a big surprise. You'd expect a company to face less bad press if it has robust environmental and safety policies in place. And it’ll be less likely to deal with industrial action if it treats its workers fairly.

If a manager excludes certain industries, their fund could underperform when those areas are in favour. The reverse is also true though and we'd expect the best stock pickers to deliver good performance over the long term despite their exclusions.

Find out more

Want to learn more about ESG and other ways to invest responsibly?

See our guide to Responsible Investment

Looking for investment ideas?

Responsible Investment sector review

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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