What is ESG investing?

ESG and sustainable investing in a nutshell

It’s easy to get jargoned-out when learning about investing, but ESG is one acronym you might want to remember. So, what is ESG investing? It’s also known as ‘sustainable’ or ‘responsible’ investing, but the ESG title (Environmental, Social and Governance) helps to pin down what that covers in a bit more detail. Overall, when we invest with ESG in mind, we are trying to maximise the positive impact of our money on the world and its inhabitants, and trying to minimise the potential negative impact at the same time. 

Environmental

This means the impact our investment or the companies we’ve invested in have on the planet. For example, does a company create pollution or release harmful emissions? Has it committed to a carbon neutral business model? 

Social

This refers to how well our investment or the companies we are investing in look after employees as well as local and global communities. For example, do the companies safeguard human rights and safety when it comes to their factories and wider supply chain? Are they involved in their local area in a positive way?

Governance

This is all about how the assets we’ve invested in are run. Are their processes fair and transparent?

Of course, these three categories are quite distinct, and many assets or companies may satisfy one or two of these, but not all of them. When fund managers are choosing what to include in an ‘ethical’, ‘sustainable’ or ‘ESG’ fund, they might be selecting on a different basis to your own measures of responsibility. 

Some people prefer to have their own lists of things not to invest in, for example the arms trade, tobacco, fossil fuels and traditional cars. 

Why should I consider ESG investing?

ESG investing has become increasingly popular in the last few years, as more and more people wake up to the potential negative effects of putting their money into companies that treat humanity and the planet badly. Younger investors, in particular, are already passionate about doing good with their investments, and as their wealth grows, this sector will only get stronger. Many people recognise that without a healthy planet and people, nobody is going to be thriving and making money in the future! So investing without an eye on ESG could, arguably, be shooting yourself in the foot.

The good news is that ESG investing is also a good idea from a financial point of view, too. Although historical performance doesn’t always tell us how something will do in the future, Morningstar points out: ‘On average, companies with a strong sustainability rating have the highest levels of historical dividend growth, at more than 5% in the past five years, while those with weak ratings offer the lowest average levels of dividend growth’.

How do I start ESG investing?

The first place to start, even if you’re not ready to move into stocks and shares, might be looking into how you can improve the ESG impact of your pension investments. Make My Money Matter has some tips here. In addition to asking your provider to make their default investment fund greener, many providers also have an ethical or sustainable fund that you can choose. 

If you are using a robo-advisor to make further investments, or another platform with ready-made profiles, you may be able to select an ESG option. However, if you’re making your own investments, you will need to do some research into the options available. Your platform may provide a list of funds they consider to be ethical or sustainable.

What do I need to watch out for? 

It’s important to realise that some investments may be categorised as ‘ESG’, but may still include industries or products that you consider to be unethical or unsustainable. If you feel very strongly about a particular strand that you definitely don’t want to invest in, you may need to drill down into the details of each potential investment, especially if you’re using a ready-made portfolio or fund. 

Additionally, it’s worth being aware that ESG investments can sometimes have higher fees than other kinds. This is often because there is a bit more management required behind the scenes to select the right investment for the category. That may change in future as more and more people want to invest in ESG, but for now, make sure you check out the fees before you invest. If you are particularly sensitive to cost, ESG might make up a portion of your more balanced portfolio rather than the entire slate. 

And, remember that even the most sustainable and ethical company may still have some negative impact. After all, nobody’s perfect. But if you want to funnel your money in a more positive direction, learning more about ESG could be a great place to start. 

This content is for information purposes only, you should not construe any such information or other material  as legal, tax, investment, financial or other advice.