Sustainable and ethical investing – what are the differences?

‘ESG’ describes three key things that fund managers – the professionals who invest your pension money – look at in addition to traditional financial factors when weighing up the pros and cons of investing in a company.

Here's what ESG is about:

• Environmental factors - How a business impacts the physical environment, such as climate change, biodiversity, natural resources, air and water pollution, and carbon emissions.
• Social factors - The impact on people, society and communities, including human rights, health and safety issues, labour standards, privacy and data security, and product liability.
• Governance factors - How companies are governed, including transparency, ownership, board independence, ethics, and executive compensation.

Fund managers will use their research into a firm and its environmental, social and governance considerations to help them form a view of the likely future financial performance of a company. Sustainable investing is based on the belief that how well a company manages these issues is critical to its future financial performance and, as a result, can help a business perform well and potentially achieve better returns for investors over the longer term.

Fund managers will engage with the companies that they invest in to create positive change on issues such as climate change and tackling plastic pollution. Although there are no hard and fast rules about how each fund manager engages with the companies in which they invest, we can give you a rough guide to the type of things that engagement usually involves. 

Direct engagement

This involves fund managers talking to and supporting businesses to foster positive change and includes:

• writing to or meeting with the directors of the company to discuss issues
• setting targets for the company to address concerns, for example implementing a clear policy to help combat climate change
• using their voting rights as a shareholder, for example to vote against executive remuneration
• withdrawing their investment if there’s no improvement from the business following engagement.

Crunching the numbers

There are many ways that fund managers can objectively measure how a company is performing in ESG terms. These include:

• how much tax it is paying and how it operates
• how it treats its workers
• whether it pays the living wage
• how it treats its customers
• a firm's work with the community
• Chief Executive Officer pay
• its energy efficiency, environmental impact and what it is doing to help fight climate change.

As the name implies, ethical investing is about investing using ethical principles as a guide. Often, it means filtering out certain types of companies and sectors – usually socially controversial industries like tobacco products and companies involved in animal testing.

The significant difference between sustainable and ethical investment is that the latter is more about investing aligned with an individual's values, rather than financial performance.

This type of investing depends on an investor’s personal views. It gives investors the opportunity to invest their money in companies whose practices and values match their personal beliefs, whether these are environmental or religious.

To sum up, the choice between sustainable and ethical investing is a question of how you feel about certain issues, such as tobacco, and how keen you are to invest aligning to your beliefs.