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Why we're all ESG investors now

Investing for the long term? Here's why you shouldn’t ignore environmental, social and governance factors.

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.

Investing with Environmental, Social or Governance (ESG) factors in mind is what ESG investing’s all about. Sadly, a lot of the time investors think it’s an approach reserved for environmental crusaders and means giving up financial returns.

It isn’t and it shouldn’t.

ESG covers an enormous subject area, and the investing styles within it sit on a broad spectrum. We think it’s important investors pay more attention to ESG issues when making decisions. But that doesn’t have to mean sitting huddled over a company’s CO2 data, or limiting yourself to investments in wind farms. It doesn’t even have to mean avoiding ‘sin’ stocks.

In fact ESG is just good business sense.

This article isn't personal advice. If you're not sure if an investment is right for you, please seek advice. All investments and their income can fall as well as rise in value so you could get back less than you invest. Past performance is not a guide to the future.

If you’re keen to make a difference

Some investors do sit within what’s known as the ‘impact’ side of ESG. This is for those that want their investment to drive good outcomes across wider society. It tends to include investing in industries that will make a positive difference, like renewable energy or sustainable agriculture.

The key thing to remember with this type of investing is it’s about proactively encouraging change. Impact investors are often prepared to give up some financial return in order to drive better social or environmental outcomes. That puts them among the most ‘hardcore’ of ESG investors.

What about a wider theme?

An alternative to impact investing is thematic investing. Thematic investing can be applied to any investing strategy – ESG or otherwise.

A thematic investor will identify a macro-level trend and choose investments that stand to gain from this trend. In an ESG context, this trend could be based on anything from gender equality to increasing recycling.

Done well this approach shouldn’t mean giving up financial return, and might even generate better returns. After all, investors often try to benefit from trends like increased ecommerce. Why would you exclude environmental and regulatory trends like decarbonisation from that approach?

However, there are challenges. Limiting yourself to ESG trends alone shrinks your investment options, and, all things being equal, that will reduce your overall return.

Pure ESG thematic investing is still a fairly extreme approach, and it’s not for everyone.

Best-in-class

That’s where Best-In-Class investing comes in. We think there’s a strong argument to say that everyone should consider this approach.

Best-in-class doesn’t exclude any type of company, it just means giving extra weight to companies with better ESG positions.

Take, for example, two very similar oil & gas companies. Company A might have really detailed ESG disclosures in its annual report, and be allocating a lot of resources to exploring renewable energy. Company B might look very similar, but it doesn’t seem to have a clear renewable strategy and its ESG details are thin on the ground.

Best-in-class would simply mean investing in company A over company B. You’re still buying an oil & gas asset, which an impact investor probably wouldn’t, but you’ve chosen to go with the ‘better’ option.

You don’t have to have particularly strong environmental views to think that Company A is better placed to manage any future transition away from carbon emitting fuels. That’s clearly a risk for the sector, and managing that risk effectively makes Company A more attractive.

Who’s this approach for?

Put simply? Everyone.

A best-in-class approach considers ESG concerns alongside other more traditional investment factors. This approach, as much as any other factor, is an important tool for limiting risk. A company making more effort to align itself with a carbon-neutral future, proactively pursuing a diverse corporate culture, or looking to exclude child labour from its supply chains is a business with better strategic oversight in general.

Given the choice, isn’t that a business you’d rather trust to potentially boost returns over the long-term, compared to one that isn’t looking where it’s going?

How do I find out about a company’s ESG credentials?

The annual report is a good place to start. You can find specific ESG disclosures here, but it’s also worth reading the Chairman’s statement. This will give you an idea of the tone of the company’s approach to the future – and the sensible ones will talk about things like sustainability and/or governance.

We also wrote about ESG assessment tools for investors, and it’s easier than you think to start breaking this topic down on a company-level basis.

Useful tools to help check a company’s ESG credentials

For those that want to take a bit more of a hands off approach, HL Investment Analyst Dominic Rowles tackled the subject back in September, including highlighting some ESG focussed funds.

Our guide to responsible investing

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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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