ESG investments

The Wealth Consultant’s Guide to ESG Investing

Investments are no longer considered solely in terms of financial returns, instead, investors are increasingly keen to shape their portfolios around their own moral values, and commit to investments that make a positive contribution to the world we inhabit. According to the FT, around 25% of all funds consider sustainability and, with that in mind, it’s not surprising that clients are reaching out to The Wealth Consultant repeatedly to enquire about ESG investment opportunities.

We are often asked, what is ESG investing?

The Financial Times Lexicon defines ESG as “a generic term used in capital markets and used by investors to evaluate corporate behaviour and to determine the future financial performance of companies.” ESG consolidates the environmental, social and governance credentials that an investor may think about before investing.

Although ESG covers a wide variety of sustainability factors, the S&P Dow Jones Index distinguishes it as either ESG or green investing, the latter being more focused on environmental participation.

E is for Environmental

This relates to a company’s interaction with the environment and how their operational activity addresses issues such as pollution, climate change, resource scarcity and reducing the carbon footprint. Risks created by business activities may be offset by a range of environmental activities such as green schemes to lower costs and increase profitability through energy-efficient practises and reduction of pollution and emissions.

S is for Social

This correlates with a company’s influence on society and the community it serves. It mainly concentrates on the internal processes and working conditions for staff including health & safety, recruitment and promotions as well as external-facing processes such as data security and product safety. Companies may reduce their risk to society through improving brand loyalty by focusing on product integrity and human rights as well as promoting health & safety initiatives or instilling a culture of community volunteering.

G is for Governance

This relates to the overarching governance of a company and is concerned with the strategic formation of the company including shareholder rights, executive pay and board diversity as well as corporate risk management, accountability and the relationship between management and stakeholders.

While investors usually know the type of investment they wish to avoid, for example, tobacco and unconventional weapons, some investors are surprised to hear that their investments can make a positive difference to the world by supporting global issues such as climate change. However, as responsible investing gains traction among younger demographics, the demand for investment opportunities that are ESG compliant is fast becoming the norm. Today, a green company with strong sustainability principles is the preferred investment for private equity, hedge funds and institutional investors around the world. So why should you (individual investors) be any different?

Why should I consider ESG investment?

Low risk

Research suggests that companies focused on ESG perform better financially. In a 2012 Deutsche Bank study, analysis of 160 academic studies, research papers and literature reviews suggested that companies taking ESG seriously benefited from a lower cost of capital as investors perceived them as low risk.

Improve the world

Incorporating sustainable investments in your portfolio will ensure you are supporting ethical companies to take responsible, positive action to develop ESG now and improve the world for future generations.

You know what you’re getting into

You can reduce your long-term risk by investing in ESG companies that are often more transparent in their processes, meaning hidden risks are identified at the outset and negative risk exposure minimised.

Higher returns with ESG investments?

Not guaranteed, but it is widely accepted that companies with strong ESG traits are the product of exemplary management teams concerned with long-term strategy rather than short-term profits. Again, the 2012 Deutsche Bank study found that 89% of the papers analysed demonstrated a positive link between ESG and stock market performance. Strategical thinking of this variety can only serve to be a competitive advantage in the markets.

What are the risks of ESG investing?

Like all investing strategies, ESG is not without risk. Credibility and accountability are critical, although the standardisation of data on ESG performance could be better managed. There are suggestions that the stock market is now better at integrating ESG information into share prices. While this may make it somewhat more challenging to use ESG analysis to get ahead, carrying out ESG research is imperative. Failure to do it thoroughly could mean undervaluing companies with a strong ESG record, over companies with less impressive credentials.

ESG factors to consider

Currently, 85% of S&P 500 companies publish detailed sustainability reports outlining their strategic objectives and achievements to date. So if you are keen to delve further into a company’s ESG profile, the best place to start your search is on the company website where you should be able to request the latest financial reports. Some of the key areas to focus on: