Ethical and environmental, social and governance (ESG) investing explained

Ethical and ESG investing is about choosing to invest in companies that you believe are doing right by this world – for example those involved in renewable energy or sustainable transport – and shunning those that you don’t.

It used to be considered a niche area of investing and one where you’d probably have to compromise investment returns but all that has changed. According to Morningstar Global Sustainable Fund Flows, there is now US$3.0 trillion invested in the ESG market across approximately 7,643 funds, as at March 2024. and the key themes associated with sustainability have become mainstream for both businesses and consumers. Although, as some ethical and ESG funds have a limited investment universe, this may still affect their performance and, as with all investments, the value can go down.

Regulating ethical, ESG and other sustainability claims

It's important for investors to be able to compare ethical and ESG investments without concerns a company is exaggerating its sustainability claims, also known as greenwashing. The Financial Conduct Authority (FCA) implemented Sustainability Disclosure Regulations (SDR) to increase transparency and investor confidence.

This means that all ethical, ESG and environmentally friendly claims must be substantiated for the life cycle of the investment. This includes:

• Are all claims correct and substantiated? FCA regulations require companies to substantiate all sustainability related claims for the entire life cycle of the investment, to improve transparency and minimise greenwashing
• Is all investment information clear and accurate? All communication and information must be fair, clear and not misleading. This includes funds on platforms including Bestinvest
• Clear guidance – before investing in funds investors can check the specific risk factors on the Key Features document. Some funds can be high risk or complex; they may also have risks relating to the geographical area, industry sector and/or underlying assets in which they invest

Navigate the green maze – follow the facts

Are you engaged with a single issue, or are you looking for a broad-based approach to investing ethically and sustainably? Once you’ve answered this, you can choose how to invest. But what do all the buzzwords mean? At Bestinvest we call this the green maze and, thankfully, we have a knowledgeable investment team to help investors navigate:

• ESG investing – also called responsible investment – aims to accurately analyse social, environmental and economic risks and opportunities as a long-term investment management approach
  
  
• Ethical investing is a broad term to describe investment approaches that consider values as well as financial returns. This means the impact a business has on society, or what they invest in such as tobacco or weapons, is taken into account
  
  
• Greenwashing is the term given when a company claims to be more environmentally friendly than it really is. If you’re choosing ethical, ESG or any other environmentally friendly investments, it’s important to make sure your investments are the real deal
  
  
• Impact investing is about making sure your investments generate a positive and measurable environmental and/or social impact alongside a financial return
  
  
• Sustainable investing balances traditional investing with ESG insights with the aim of improving long-term outcomes. Investing in themes or assets specifically contributing to sustainable solutions such as sustainable agriculture, lower carbon tilted portfolio, gender equity and diversity
  
  
• Sustainability outcomes refers to the positive and negative effects of investment activities on everyone and / or the planet, and typically refer to global sustainability goals such as the UN Principles for Responsible Investment (PRI)¹
  
  
• Important to note – sustainability-focused portfolios exclude certain industries and companies that do not meet their criteria. This can result in a significantly different portfolio performance compared with the broader investment market. As always, it’s important for investors to remember the value of your investment can go down as well as up, you can get back less than you originally invested

Investors – do your research

Investors need a lot of time and knowledge to choose and buy shares in companies that align with their values. Many opt instead to buy funds that have different investment processes to conventional funds and can vary on a fund-by-fund basis, so it is important to do your homework before investing.

Thankfully stricter regulations challenge unsubstantiated and misleading sustainability claims, so it’s easier for investors to recognise credible investments, and make more informed investment decisions.

Remember, if you are unsure about the suitability of ethical or ESG investing for your financial goals it’s a good idea to chat to a qualified expert.

Source

¹ Principles for Responsible Investment (PRI) – the six Principles of Responsible Investment