ESG: Should you consider these areas when investing?

When you’re deciding where to invest, what do you consider? The historical returns probably come out top. After all, you’re investing to grow your savings. However, there are plenty of other areas to consider too. One growing area of focus is on ESG topics.

What is ESG?

ESG stands for environmental, social and governance. These represent three key areas that investors may choose to reflect on when deciding where to place their money. Combined, ESG issues can help measure sustainability and the working practices of companies. Whilst this may be linked to making more ethical financial decisions, incorporating ESG issues can help you determine potential future financial performance and, therefore, returns or risks.

So, what does each of these three pillars cover? The breadth of concerns that can fall under these three pillars is vast and can be interpreted differently but we’ll take a look at some of the key areas.

Environmental: Within this pillar topics focus on the impact business operations have on the environment and how, in turn, environmental changes will have an impact on activities. Among the biggest concerns in this category are climate change, the depletion of natural resources and environmental degradation.

Social: The ‘S’ in ESG focuses on the human impact. This could be to individuals, for example, human rights issues, or to groups, such as the effects on communities. Taking social factors into consideration means looking at the company’s relationship with people, communities and other businesses.

Governance: This pillar takes a look at how the company is run and its relationship with employees and shareholders. Governance concerns may include diversity within the workforce, management structure or executive compensation.

How can ESG issues help you pick sustainable investments?

Incorporating ESG issues in the investment decision-making process is increasingly being used by those that want to invest ‘ethically’ as it can act as a way to compare values with potential investments. This allows investors to measure investments with a ‘double bottom line’; return and impact.

However, ESG can help you pick out investments that are more sustainable. When you consider that your investment goals are likely to be long term ones, sustainability is incredibly important and can help deliver returns. There are numerous ways using ESG factors when investing can help, such as:

  • Governments around the world are increasingly facing pressure to limit climate change. As a result, it’s likely that companies heavily contributing to the global issue will face further restrictions and costs to continue operating if they aren’t proactively planning for these changes. It may mean that profits fall significantly over the long term, affecting the returns that investments deliver,
  • Consumers are becoming more interested in how products are made and the supply chain. A supply chain that’s perceived as exploiting people, for instance, could lead to sales falling as consumers choose rivals to reflect their ethical views. As a result, being transparent about the labour that’s used to produce consumer goods and ensuring minimum standards are adhered to can help preserve a customer base and act as a selling point.

The trend of incorporating ESG factors

Considering ESG factors isn’t a new trend, it’s been used for decades to measure the sustainability of companies and to measure the wider impact of companies. It has, however, become more prominent.

According to Morningstar, assets under management in ESG funds increased 60% between 2012 and 2018, from $655 billion to $1.05 trillion. Back in 2017, a Morgan Stanley report indicated that three-quarters of investors were interested in assessing how sustainable their investments are. This growth has partly been attributed to the millennial generations, which are more likely to take other factors into consideration when investing.

Investing with ESG in mind

Incorporating ESG factors into your investment strategy can strengthen your portfolio and give you confidence in returns over the long term. So, how do you go about investing with ESG matters in mind?

You could, of course, select individual companies to invest in that reflect your ESG priorities if you’re confidence handling your own investment decisions. However, this would require an enormous amount of research and work to identify which businesses align with your strategy. You’d also need to keep on top of changes with the company and external factors that may have an influence.

The alternative is to use ESG funds, meaning fund managers will pick investments based on defined ESG criteria. Different funds will focus on various areas, so it’s important to understand what the ESG criteria is before investing,

Remember, it’s not just your portfolio that contains investments. If you’re paying into a pension, it’s likely that your retirement savings are invested too. If it’s a Defined Contribution pension, you’ll typically be able to choose between several different funds. Your pension providers should be able to provide information on how each of these funds uses ESG factors when making investment decisions.

If you’d like to learn more about ESG investing and how these factors may already influence your portfolio, please contact us.

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.