Are you the kind of person that buys organic food and seeks out ethically sourced clothing? And do you have an electric car parked in your driveway or, better yet, shun a car entirely in favour of public transport? If so, then chances are you want your investments to follow a similar trend. Cue ESG (environmental, social and governance) investing. It doesn’t guarantee that your chosen investments are perfectly sustainable and ethical. But by filtering out investments with a poor ESG score, you can help ensure that their negative impact on our planet and its people is kept to a minimum.
Environmental, social and governance (ESG) investing is where you invest in a socially conscious and ethical manner while still aiming to make good financial returns. ESG proponents will be drawn to investments that positively impact society and the environment and avoid those that have a negative impact.
So, if you habitually seek out green energy options and avoid buying from companies that have a poor reputation for the treatment of supply chain workers, you probably also want to avoid investing in oil or in stocks in unethical retailers.
ESG investors will use a number of measures to assess and screen potential investments before taking the plunge
As the name suggests, 3 key measures are considered part of ESG investing: environmental, social and governance.
Is a company pumping pollutants into the air? Does it add to the tonnes of plastic in the ocean? Is it cutting down trees or planting new ones? Companies with a good environmental score aim to prevent pollution, reduce emissions and keep their negative impact on climate change to a minimum (or even have a positive impact).
This focuses on how a company impacts society as a whole. Does it engage effectively with local communities? Are its employees happy, healthy and fairly rewarded? Does it have strong diversity and inclusion policies? And does it have suppliers or partners that share its values? A company with a good social score promotes good health – mental and physical – and protects human rights.
This focuses on the way the company is run. Does it have transparent accounting (including the tax that it pays) and a clean record when it comes to bribery and corruption? Governance also covers issues such as the gender pay gap and shareholder rights.
Each of the 3 key ESG measures are big topics that encompass a wide range of issues. The table below isn’t a comprehensive list. But it outlines some of the main considerations that might fall into each facet when assessing how well a company delivers on ESG measures.
| Environmental | Social | Governance |
|---|---|---|
| Biodiversity | Child labour and slavery | Board diversity |
| Climate change | Community engagement | Bribery and corruption |
| Deforestation | Diversity and inclusion | Business ethics |
| Greenhouse gas (GHG) emissions | Equal rights and opportunities | Compliance |
| Natural resource conservation/depletion | Health and safety | Management of conflicts of interest |
| Treatment of animals | Human rights | Executive pay |
| Waste and pollution | Philanthropy | Political activities |
| Water and energy efficiency | Social justice | Tax strategy |
| – | Working conditions | – |
All of these types of investing fall under the broad term “ethical investing”, and the terms may often be used interchangeably. Each aims to, at worst, avoid investments having a negative impact on our planet at the people on it. At best, their approach is to make the world a better place.
If we were to be pernickety about the detail of terminology, there are some subtle differences.
Assessing an investment’s ESG performance would be quite a big task for an individual investor. To effectively make such an assessment, first you’d need to pull information from a wide range of different sources, including a company’s own reports, news reports and other third-party research and analysis. Then you’d need to analyse the data and work out what it actually means in practice.
Fortunately, there is a shortcut in the form of ESG scores. These are published by a number of third-party providers. However, they all use slightly different methods for calculating their scores. There’s no single, universal method for measuring an investment’s ESG credentials.
An ESG score aims to measure aspects of a company’s environmental, social and governance performance. It’s designed to be a quick way to help investors choose what they want to invest in.
ESG scores are a bit like credit scores. All the services that determine the scores have slightly different criteria and look at slightly different factors, but ultimately, they tend to reach the same general conclusions.
Scores may be expressed in different ways. Sometimes, you’ll find a numeric score out of 100. Check carefully whether higher scores or lower scores indicate better ESG values, as this may vary. You may also come across the MSCI ESG score, which uses letters (AAA is the best, and CCC is the worst).
Bear in mind that an ESG score is not a full representation of a company’s impact on the world. This is in part because it is – by necessity – calculated using what an organization discloses. An oil company, for example, will typically be regarded as having a bad environmental impact. But its ESG score may not be abysmal. This will in part depend on the regulatory disclosure requirements in the country where the company is based. So, if you want to invest ethically, you may want to use criteria other than the ESG score alone to decide.
If you are serious about ESG investing (or struggle to sleep at night), you can read the UK Financial Conduct Authority’s ESG Sourcebook, which includes disclosure requirements for UK companies.
There are a number of services that calculate ESG ratings for companies you might be thinking about investing in, usually providing this alongside other data or services. These include the likes of Bloomberg ESG Ratings, ESG Book, FTSE Russell ESG Ratings and Moody’s ESG – among others. To access a provider’s ESG scores, you can subscribe directly (some may charge a fee for their services).
Alternatively, some online investment services partner with ESG rating providers to publish ESG scores on their platforms, so it’s worth checking if your chosen platform does so.
Finder also publishes ESG scores for many of the companies it reviews. Just search for the name of the company you want to buy shares in (for example, “How to buy Shell shares”) and look for the section on ESG.
The scores you’ll see in Finder reviews are:
You may spot an addition to the list here: the controversy score. This doesn’t feed into the total ESG score. But it’s worth looking at and is typically shown alongside the company’s ESG score. The controversy score reflects any incidences of controversy that the company has been involved in. It considers news stories, lawsuits and spills. It’s based on the company’s impact on the environment and society.
When it comes to the big DIY vs advised investing approach, the same principles apply to ESG investing as to any other type of investing. It’s a personal choice and all down to your specific circumstances.
If you have the time and inclination to be hands-on with your investments, you can use an online investment platform plus other sources of financial analysis to do your own ESG research and choose exactly what to invest in. Many online platforms may offer scores and other tools to help you choose. This is likely to be the cheapest option but requires more work on your part.
Alternatively, if you’re time-poor or simply need a bit of help making sense of ESG data and regularly monitoring and rebalancing your portfolio, you can employ a financial adviser to put the work in for you and make recommendations based on your specific requirements. The main downside is, of course, that it’ll cost more. But the adviser, rather than you, will be on the hook if their recommendations turn out to be unsuitable for you. (Bear in mind that poor investment performance alone doesn’t automatically mean a recommendation was bad, as long as it was suitable for your needs at the time).
There’s no simple answer to this – an investment’s performance and returns will depend on the specific stocks or funds you choose to invest in.
If performance is more important to you than ESG, you should prioritise research into this when choosing which companies to invest in, then layer on ESG scoring once you’ve drawn up your shortlist.
If you want to invest in assets that have been filtered for their ESG credentials, you have 2 main options.
It depends on your priorities and your investment strategy. If ESG measures are important to you when choosing which companies to buy shares in, and you want to feel good about your investment assets, then looking for stocks with a good ESG score makes sense.
That said, at the end of the day, you are unlikely to be investing purely for the feel-good factor. You want your investments to make money and help you achieve your goals, too. So any ESG considerations should always be made alongside robust research into a company’s financial soundness and potential for good returns. Fortunately, you should be able to find investment choices that do both. If you need help deciding, consider speaking to a regulated financial adviser.
There isn’t a black-and-white answer to this. As is always the case, it depends on the specific asset you’re considering and its attributes outside its ESG credentials. A large, stable, blue-chip company with a good ESG rating will typically be less risky than a small startup with an equivalent rating.
In terms of the risk of ESG funds, there are a couple of schools of thought. On one hand, some might argue that ethical funds can be more volatile than normal garden-variety funds because they may not include stocks typically used as defensive holdings against downturns. Tobacco, for example, is often chosen by fund managers because it is not particularly cyclical.
If a fund foregoes the staples of tobacco and fossil fuels, it may instead look to technology to fill its ranks. However, technology stocks tend to be more volatile. This can result in a fund whose returns vary more than their mainstream counterparts. Some of the big fossil fuel companies are also the biggest and most reliable payers of dividends. This means that you might not benefit from the compounding effect of reinvested dividends that you might get in a mainstream fund.
But there’s a counter-argument that many ethical industries attract government subsidies, which can help make ethical companies more stable and with more potential for growth. Green energy companies, for example. Meanwhile, ethical funds prioritise good governance in the companies they include. This also fosters more stability and less volatility.
The key is to think carefully about what you want your money to do and look closely at the approaches used by different investments, from both an ESG and an overall risk perspective, before committing.
Greenwashing is when a company, in a bid to attract customers, makes ethical or sustainability claims that can’t be substantiated when you dig into the information behind them. It can apply to anything from food to clothing to investments.
And yes, there is a risk of greenwashing when it comes to ESG claims. In fact, in 2022 RepRisk, an ESG data science company, analysed ESG risk incidents among companies over 2 years, including potential violations. It found that, over this period, 1 in every 5 risks was linked to greenwashing. Lobbying by companies and claims about their offsetting practices were 2 major contributors.
In October 2022, the Financial Conduct Authority (FCA) proposed a package of new measures to tackle greenwashing, including investment product sustainability labels and restrictions on how terms like ‘ESG’, ‘green’ or ‘sustainable’ can be used. The FCA intends to publish final rules by the end of the first half of 2023.
It seems likely. In fact, a number of big analysis firms and thinktanks – including Bloomberg, Deloitte and McKinsey – have published articles with titles very much along the lines of “ESG investing is here to stay”.
There are several reasons cited for this, including:
Regulatory pressure. In recent years, UK regulators and policymakers have prioritised ESG investment regulations that will compel companies to be more transparent about their ethical practices. Businesses are unlikely to want to be seen as failing on ESG measures.
Industry commitments. The UN’s Sustainable Development Goals (SDGs), and many company’s linked net zero targets, have ramped up industry focus on ESG.
Simple consumer demand. ESG considerations are becoming more important to investors, particularly younger generations. There may come a time when striving for a good, or at least acceptable, ESG score is essential for all companies if they want to attract investment.
All of these are, of course, linked to the fact that sustainability, in its broadest sense, is simply becoming more fundamental to our way of life. The threat to our planet and way of life if all of us –including industry – do not take steps to be more ethical and sustainable is undeniable. And taking a company’s ESG scores into account is one step that investors can take to help ensure that their investments at least do not act against the best interests of our planet and its residents.
If you want to invest in a way that takes into consideration how environmentally friendly, socially conscious and well-governed an investment is, then making use of ESG scores can be a good filter. But there are lots of different ESG rating companies around, and each operates and scores differently, so make sure you read the detail behind their analysis to make sure you know what the scores actually mean. In some cases, a decent ESG score may simply mean that a company is less evil than others rather than necessarily having a positive impact.
And remember that ESG scores have nothing to do with an investment’s performance, so shouldn’t be the only thing you take into account. After all, for the vast majority of people, the whole point of investing is to make money to fulfil their goals. Socially conscious investors may be willing to sacrifice the highest possible returns in favour of assets that are less damaging to our planet, but most will be looking for a sweet spot that strikes a balance between performance and ESG impact.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
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