Environment, Social and Governance (ESG) investing is on the rise. Learn what ESG investing is, and the key factors to know when investing ethically. Capital at risk.
When you think of investing, what image springs to mind? If it’s the ruthless, Gordon Gekko-esque figure of the 80s and 90s, push it aside. Over the past decade, investing has gone and got itself a conscience.
The value of an investment is no longer just about how much money it can make you – but also about the positive impact it can have on the world. And that’s where ESG investing comes in.
ESG – or Environment, Social and Governance investing, for those not keen on acronyms – has been gaining popularity particularly over the last 12 months. A 2020 survey by Big Window showed that 69% of investors considering ESG factors had started doing so within the last 12 months.
And it’s not just the younger generations getting involved either, the 2020 study found that 48% of those considering ESG factors in their investments are over the age of 45. But what does putting your money into ESG funds actually mean – and how can you be reassured your money is actively doing good? Here’s what you need to know about ESG investing.
What are the ESG factors?
Taking an ESG approach to investing means that an investor will take environmental, social, and governance criteria into account when they’re considering investing in an asset.
So, if an investor was looking at putting their money into a company, they’d assess:
How the planet is treated
Environmental factors look at how the natural world is being affected. Factors such as a business’s energy consumption, their policy on climate change, their waste production, deforestation, biodiversity, and waste of water all play a part.
How people are treated
Social factors focus on how people and their lives are affected by the company’s community engagement, how well they protect human rights, and address issues such as modern slavery, their employee relations, gender diversity, and their working conditions.
How a company is run
Governance factors look at the way the business is run – such as the quality of management, the diversity of the board, conflicts of interest, whether there is bribery or corruption, whistle-blower schemes, and contributions to politics.
What about return on investment?
Evaluating ESG criteria is a way of enhancing traditional financial analysis, not replacing it. The aim isn’t solely to make sure that investment is ethical; the main objective of ESG, as with any investment, is financial performance.
Of course, as with any investment, the value of ESG funds could always go down as well as up and you could get back less than you put in.
ESG and other responsible investments
Unlike ESG, some responsible investments are focused on specific sustainable outcomes.
For example, some ethical investments try to exclude so-called sin stocks, like investments in tobacco, oil, or gambling. ESG, meanwhile, goes one step further. Instead of focussing on excluding the bad, it positively includes the good.
Rather than simply removing all sin-stocks, an ESG approach seeks to include assets that score highly on those all-important environment, social and governance factors. So you can be assured that your money is being put into companies that have been actively identified as doing good.
The differences go beyond ethics, too. From a financial point of view, ethical investments may prioritise social responsibility over profits and are sometimes criticised for the difficulty that presents in building a truly diverse investment portfolio.
ESG instead puts potential returns on investment and responsible investment on more equal terms.
How is ESG performance calculated?
There’s no standard way to calculate the ESG performance of a fund, so it’s hard to pinpoint an exact metric.
Different companies use different measurements to give an ESG score, which can sometimes make it difficult to know how 'green' a company really is. For example, we work with MSCI, who use a grading system with letters AAA-CCC, where 'AAA' is the best and so on.
Overall, an ESG score is a combination of different metrics that looks at whether companies are meeting their ESG targets; their impact on climate change, human rights and the environment, among other things; and whether they're doing all they can to stretch themselves to meet ESG values.
Are there ESG risks?
Just like traditional funds, ESG funds come with a range of risk ratings – some are for the more cautious investor, others for the more adventurous. And everything in between. You’ll find more details on the risk rating of each ESG fund on its fund fact sheet. ESG encompasses different styles of investing too, and each one comes with its own risks.
For example, if you invest ethically, you might avoid companies you don’t like, such as carbon-emitting companies. But not investing means you have no say whatsoever in what they do. If you do invest, you could be a part of changing what they do for the better – you can use annual general meetings, where shareholders get to vote on company policies for the next 12 months, to try and encourage better revenue schemes.
With impact investing, you might choose a cause that you really care about – such as climate change or human rights – and build your whole portfolio using companies that avoid or combat these issues. But this could mean you ignore something else that you (and other people) care about, such as bribery and corruption in a company (governance) or gender and racial diversity on a company's board (social). You could be too focused on one problem which poses the risk of a lack of diversification in a portfolio.
What is greenwashing?
ESG funds are also at risk of greenwashing.
This is when companies say they’re much greener than they are. For example, you might buy a specific company’s product because they claim they’re ‘committed to being sustainable at every level’ and will ‘reduce their plastic by 100% by 2025’, but if there’s nothing binding in their mandate that says they must do this, they can change their minds whenever they want. So, you’ve been greenwashed.
There’s also the question of who greenwashing affects the most: the investor or the company? The investor doesn’t get what they thought they were getting, and the company also risks its reputation if they mislead people about their ESG values.
To avoid greenwashing, keep your eyes on the following:
- Look beyond the name of the fund. Terms like ‘sustainable’ and ’responsible’ may sound reassuring, but it doesn’t mean that the fund will meet your values or your aims, sadly
- Do some light digging and look through the fund fact sheet and Key Investment Information Document – this is where you’ll find the fund’s stated aims and its performance
How to find ESG funds
If you’re directly investing in an Aviva Stocks & Shares ISA, Pension or Investment Account, or are looking to open one – good news. There’s a range of responsible investment funds available across them all. Plus, if you have an existing pension with us, workplace or personal, there are ESG funds on offer for you too.
Interested in aligning your investments with your conscience? Find out more about Aviva’s investment options here. As with all investments, it’s worth speaking to a financial advisor first to make sure it’s the right choice for you.