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ESG investing: What do you need to consider?

Category: Investments

Do you want to invest with your values in mind? Incorporating ESG factors can help you align investments with your ethics, but it’s not as simple as just choosing an ‘ethical’ fund.

ESG investing has been rising in popularity as more people look at the impact their portfolio is having. ESG refers to the three central factors measuring sustainability and societal impact: environmental, social and governance. Investors that want their values to be reflected in their investment decisions can use these to assess impact alongside financial returns.

  • Environmental: This pillar focuses on the environmental impact companies have, it may include how firms are contributing to climate change, depleting natural resources or environmental degradation.
  • Social: This factor looks at a company’s business relationships, for example, does the firm have adequate working conditions? What consumer protection does it have in place? And does it work with suppliers that hold the same values as the business claims to hold?
  • Governance: Finally, governance looks at how the company is run, such as its management structure, executive compensation and employee relations.

The combination of these three factors can build a picture of how sustainable a firm is.

More investors are beginning to consider ESG factors when making decisions about portfolios and pensions. It’s part of a wider trend in considering the impact our actions have. For example, more people have changed their shopping habits to reflect ethics, such as choosing Fair Trade products in recent years too. ESG investing can be seen as an extension of this.

Does ESG investing mean lower returns?

You might want to consider ESG factors in your investment decisions, but it’s natural to worry about the impact this will have on returns.

However, research suggests that considering ESG factors doesn’t necessarily mean lower investment returns. In fact, as you should be investing for the long term, assessing sustainability could prove beneficial. Recent figures from the National Employment and Savings Trust (Nest) highlight this. Some 8.5 million people use Nest to save for retirement, roughly a quarter of workers.

Based on an individual on an average annual full-time income (£29,588), making the minimum pension contribution level since the start of October 2012 to September 2019:

  • An individual investing through the default ‘2040 retirement date fund’ would have a pot worth just under £6,000
  • Those using Nest’s ‘higher risk’ fund would have £6,241
  • Whilst those using the ethical fund, which considers some ESG factors, would have £6,258

Of course, it’s impossible to predict how investments will perform and all investments involve some level of risk. Whether you’re considering ESG factors or not, it’s important that investment decisions consider your risk profile and goals as well as being balanced. But ESG investing doesn’t automatically mean sacrificing financial returns.

3 things to consider when weighing up ESG investments

1. What are your risk profile and goals?

These should be the foundation of every investment decision you make. Whether considering ESG factors or not, there’s no one-size-fits-all investment strategy. Thinking about what you want to achieve when investing can help you set out a time frame, which should be a minimum of five years, and inform how much investment risk is appropriate. Your overall risk profile should also consider other areas, such as existing assets, capacity for loss and attitude to volatility.

2. What are your ESG concerns?

One of the challenges with ESG investing is that it’s highly subjective. ESG covers a wide range of areas. Whilst you may prioritise the social impact companies have; others will be more concerned about the environmental effects. Even within each pillar, there’s an array of different concerns. It’s worth spending some time thinking about what is most important to you.

This also ties in with how you will invest.

There are now plenty of ‘ethical’ funds to choose from. However, you may find these don’t perfectly align with your ESG values, so compromises may have to be made. The alternative is to select your own investments. However, one of the drawbacks here is that the research to understand a firm’s commitment to ESG factors can be incredibly time-consuming.

3. Which ESG investment strategy is right for you?

There’s more than one way to include ESG factors when investing. For individual investors, there are two key ways of doing this.

First, negative screening means avoiding those companies that don’t match your ESG criteria. Again, this may need to involve some level of compromise. The complexity of modern businesses may mean negative screening strategies cut out a large portion of investment opportunities without any leeway. Many funds using this method, for example, will avoid firms that derive more than 5-10% of profits from certain activities they want to avoid.

Second, positive screening means actively investing in companies that promote the ESG values important to you. This may mean actively looking for opportunities in certain sectors or even dedicating a portion of your portfolio to this area.

Let’s say climate change and fossil fuel use is something you want to reflect in your investments. A negative screening process may mean cutting out firms that are involved in the fossil fuel industry. In contrast, a positive screening method could mean diverting a portion of your portfolio towards companies that are focused on renewable energy.

Please get in touch if you’d like to discuss your current investment portfolio or new opportunities. We’ll help you build a portfolio that reflects ESG factors as well as your circumstances. Our goal is to provide you with confidence as you invest for the future.

Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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