Environmental, Social and Governance (ESG) investing has become increasingly important over the last decade.

International financial adviser firm The Fry Group  gives their views of ESG investing.

Types of ESG investing

There are four main areas of ESG investing:

Responsible ownership and engagement: this approach encourages companies to improve their practices in areas where investors believe ESG related risks and/or opportunities could be managed better for the benefit of shareholders.

Avoidance or negative screening: this method avoids companies involved in activities that are ‘unacceptable’ or ‘unethical’. This typically works by grading companies based on a list of undesirable business practices.

Positive screening strategies: investments are directed towards companies that meet an investment manager or fund’s ‘positive’ ESG objectives. Funds may focus on single sector issues in a narrow range of industries or companies that achieve certain standards.

Impact investment strategies: this aims to generate specific beneficial social or environmental effects in addition to financial gains. Its purpose is to use money and investment capital for positive social results including renewable energy and sustainable agriculture.

Why consider ESG investing?

Many investors choose to consider ESG investing in order to ensure any investment decisions reflect personal beliefs and values. As a result, they choose to support companies who are making informed, responsible decisions which consider their wider societal and global impact. In this way investors can achieve peace of mind that their investments are creating a positive effect.

How does ESG investing work?

The number of ESG issues a company considers will help determine whether it offers a good fit in terms of ESG investing. Ultimately it is how those issues are dealt with, referred to as an ‘ESG approach’, which determines investment strategy. Fund managers take time to understand the company’s ESG strategy; mainly the issues it considers and the approaches it applies to those issues.

It is important to remember that ESG factors are not the only relevant aspects when it comes to this type of investing. Generic factors impact ESG funds too. Managers will consider asset type, the market capitalisation of the stocks held, geographic spread and timing, investment aims (for example growth or income), benchmarking decisions, fund manager skill and charging structures.

Investors contemplating an ESG approach should consider whether there are any social, ethical, environmental or religious issues which are important when it comes to making any investment decisions. If so, it’s likely investors will be asked some questions by their financial adviser to identify what types of ESG investments might be most appropriate given these ethical and financial needs and objectives.

This then helps to inform the process of selecting appropriate investment managers or funds. This can be complex as ESG investments consider a diverse range of environmental, social and governance issues and approaches.

For example, most funds take environmental concerns into account; not just those that are environmentally themed. Additionally, most avoid significant exposure to tobacco, armaments and other negative selection criteria. It is therefore important to focus on the key features which are important to each investor.

How do ESG investments perform financially?

There is also growing evidence of a positive link between good ESG practice and company performance, perhaps in no small part due to the extra analysis which takes place into ESG funds, and the work being taken to identify long-term trends.

Companies which incorporate ESG themes are also likely to be more resilient to future changes given they have already made, or are in the process of making, the changes needed as regulation tightens and attitudes evolve.

What is the current state of the ESG investing market?

In the past, ESG investing has been seen as a niche investment approach, for a relatively small number of people with specific requirements. This has changed significantly in recent years, with a growing awareness of environmental issues such as climate change and an increasing understanding of social issues and human rights. As a result, many people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.

Further reading

The value of values: Changing perspectives on sustainable investing

Five ways that investing could help create a better planet

Science and investing: Addressing the climate imperative