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Investing in ESG (i.e. assets which promote ethical causes in the environment, society or governance) have gained rising popularity in recent years.
Consumers, corporations and governments are increasingly trying to promote their “green credentials” and demonstrate their contribution towards “net zero”. Yet, for investors, it is important to never forget that ESG is, at its core, also about generating strong returns.
How can you get the most out of ESG investments in 2023? What are some common pitfalls to avoid? In this guide, we offer some insights to help you address those questions.
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What is ESG investing?
There is a long history of investors wanting to use their money towards a positive moral cause. In 1758, for instance, the Quaker Philadelphia Yearly Meeting barred members from investing in the transatlantic slave trade.
The concept of socially-responsible investing (SRI) started to emerge in the 1970s as more Western investors sought to limit their portfolio exposure to tobacco, weapons or companies involved in human rights violations.
It was not until the 2000s that “ESG investing” gained popularity. This tried to capture the importance of not just recognising social issues when investing, but also those pertaining to governance and the physical environment.
Getting started with ESG investing
The first step is to make sure you have a firm understanding of ESG investing. This means educating yourself about the principles and frameworks underlying it.
After all, ESG investing can cover a broad range of ethical considerations such as carbon emissions, resource efficiency, labour standards, diversity and board independence.
It is difficult to focus on every ESG cause at once with your portfolio. So it can help to ask yourself which ones matter most to you and familiarise yourself with those. Learning about the various industry-specific ESG guidelines and rating systems can also be useful.
For instance, the FTSE4Good Index Series collates some of the most ethically-responsible stock indices, scoring their performance against CSR (corporate social responsibility) measures.
Defining your investment goals is also crucial to maximising ESG opportunities. In particular, do you value certain ESG factors over others? Perhaps you care more about environmental issues than gender equality in boardrooms – or, vice versa.
Also, what do you want your ESG investments to achieve? Do you want them to provide a steady source of investment income (dividends), or are you more focused on capital growth? Here, you may need to consider your wider financial planning goals, such as retirement.
Choosing ESG funds and investments
It is important to note that, just because a company or investment fund attaches an “ESG label” to itself, does not mean it necessarily aligns with your ESG values as an investor.
In 2023, there is still no universally-accepted criteria or set of regulations governing how, and when, companies and funds can do this. This means that you should always look under the hood of different investment opportunities, to check their ESG credentials before investing. Do not simply rely on what they say about themselves.
It is important to also conduct this due diligence periodically to check that your chosen companies (and/or funds) still align with your values and still perform to your expectations. Over time, some of these may veer of course – leading you to want a portfolio rebalance.
With “ESG funds”, pay particular attention to the costs (e.g. management fees) and the inherent diversification of the holdings.
Certain ESG funds – e.g. those which are actively managed – may justify chargeing a higher fee due to the work involved for the management team to choose the different fund holdings, buying and selling on behalf of investors.
Some ESG funds are not as “pure” as investors think. One study suggested that ESG funds may have 68% of their assets invested in the same ones as non-ESG funds, yet the cost may be as much as three times higher.
This study also highlights a potential diversification risk to ESG funds. After all, if an investor believes that her ESG funds hold different assets to her non-ESG funds, yet the underlying assets are almost 68% the same, is she really “spreading out her risk”?
One effective way to address these problems is to build your own portfolio of ESG investments rather than relying completely on funds to do it for you.
This can be particularly effective when approaching early-stage investments, such as startups and other private companies, which may qualify for tax-efficient schemes such as EIS (the Enterprise Investment Scheme).
Some of the most exciting, thriving and innovative ESG companies are in the early-stage sector. They can also offer some of the greatest potential for higher returns (albeit at a higher risk).
Being part of a professional investor network, such as ours at Bure Valley Group, can help you explore some of these pre-vetted opportunities alongside other seasoned investors who can offer their own insights and experience.
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