What is ESG investing and is it good for your wealth and the world?

ESG (environmental, social and governance) investing allows you to diversify your investments towards building a more ethical portfolio.

Socially responsible investing has become a hot topic over the last few years, particularly during the pandemic. With many providers scrambling to offer ESG options to investors, during the first quarter of 2021, 169 new funds with ESG criteria were launched.

Furthermore, according to Bloomberg, global ESG assets are expected to exceed $53 trillion by 2025. This represents more than a third of the $140.5 trillion in projected total assets under management.

What are “ESG investments”?

To clarify exactly what sustainable investing should look like, ESG investments are defined through a set of criteria used to grade investments.

ESG criteria measure how investments or companies perform in certain categories.

Environmental factors look at the conservation of the natural world, social factors examine the treatment of people both inside and outside the company, and governance factors consider how a company is run.

How do ESG investments perform?

While sustainable funds are growing in popularity, some investors worry that investing with an ethical stance may not deliver the investment performance they desire.

Because ESG funds have only been around for a relatively short time, there is limited data on the long-term performance of ESG funds. However, according to research published in the Financial Times, performance concerns appear to be unfounded.

Research carried out by Morningstar in 2020 found that the majority of ESG strategies have done better than non-ESG funds over one, three, five, and 10 years. And that “close to 6 out of 10 sustainable funds delivered higher returns than equivalent conventional funds over the past decade”.

The study also found that sustainable funds outpaced traditional funds during the market sell-off sparked by the coronavirus in March 2020, with average excess returns of up to 1.83%.

Companies that score high on ESG also tend to be well-run businesses. Because they treat their stakeholders well, address their environmental challenges, enjoy more conservative balance sheets, and have lower levels of controversies, these high-scoring ESG firms are often more resilient during market downturns.

Of course, considering ESG factors is no guarantee of investment performance. As with any stock market investment, you’ll still experience short-term volatility and there is always some risk involved.

3 ESG investment pitfalls to avoid

Because ESG investing is enjoying a bit of a moment, there are a few things to watch out for. Here are three of them:

1. Greenwashing

Watch out for fancy jargon and don’t rely on inspiring wording on marketing material promoting ethical investments. If you’re investing yourself, make sure you research the underlying funds and check that the holdings are as ethical as the bumf promises.

2. Don’t discount oil companies

Don’t automatically discount large organisations that may provide potential for growth. Although you may think Shell and BP are far from ethical, companies like these are the driving force behind renewable energy innovations and other “green” projects.

3. Avoid a hardcore ethical approach

It is important to maintain a diverse portfolio. Investing your wealth in pure ethical funds may skew your portfolio to lean too heavily in one area of the economy or rely on too few companies. This will have a detrimental impact on the structure of your portfolio, which can effectively increase the risk.

Identify your ESG goals

Since ESG covers a wide scope, it’s helpful to have some understanding of what matters most to you when considering potential ethical investments.

Take some time to examine your values and identify what is most important to you.

For example, do you want to ensure your investments are saving the planet through low carbon emissions and sustainable measures to reduce the impact on the world we inhabit? Or are you more concerned with the values by which an organisation treats their staff?

Once you are clear on what matters to you most, you’re ready to find those funds that reflect your ethical objectives.

How First Wealth can help

We’ve set up ESG portfolios so clients can choose to invest in a more sustainable fashion while staying aligned with the First Wealth evidence-based investment philosophy.

Daniel Evans is Head of Technical at First Wealth and heads up our investment committee. He designs our ESG offering to align our investment beliefs with our sustainability goals.

ESG investing presents a couple of interrelated challenges. First, the limited number of ESG funds on the market makes it difficult to go to the lengths we’d like. And second, this fundamental limitation means that a portfolio fully committed to ESG investing wipes out a large majority of investments available.

“Typically, ESG was a space dominated by active fund managers and higher costs. Now companies like Dimensional and Vanguard are doing great things […] over time, this is going to get even better.” – Daniel Evans, Head of Technical

We have set criteria that allow us to screen out the products that we would and wouldn’t invest in. We score funds or products according to specific ESG credentials. And because we have a score for each factor, we can more effectively match your objectives to the investment opportunities.

“People are more aware of the impact they have on the environment. They want to lessen their carbon footprints, they want to invest in companies that do good by themselves.” – Daniel Evans, Head of Technical

Stepping in the right direction

With clients more aware of ESG investments and because we are now a B Corp company, it’s in all our interests to take steps to improve the sustainability of our practices.

The ESG market is still growing and as it does, we work to keep up with what is available to you and find those funds that will put your money to work while doing good.

If you’d like to learn more about ESG investing and how you can invest your money and do good for the world, please get in touch. Email hello@firstwealth.co.uk or call 020 7467 2700.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.