Over the last decade, there has been a dramatic shift in the way that investors allocate their capital. Whereas in the past the focus was mainly on maximising financial returns, investors today are increasingly directing capital towards ‘responsible’ or Environmental, Social, and Governance (ESG) investing strategies, to play their part in building a more sustainable world for future generations.
In this article, we will look at the basics of ESG investing and highlight why ESG investing is important. We will also look at how investors can incorporate ESG into their portfolios.
ESG investing explained
Sometimes called ‘sustainable investing’, ESG investing is a form of socially responsible investing that involves considering Environmental, Social, and Governance factors alongside traditional financial metrics when making investment decisions. The aim is to generate attractive long-term financial returns while simultaneously investing in companies that are having a positive impact on society and the environment.
For a long time, ESG investing was very much a niche strategy. However, in recent years, it has well and truly gone mainstream. Thanks to a growing recognition among investors that ethical considerations are important, ESG-related assets now account for around one in three pounds managed globally, according to the Global Sustainable Investment Association (GSIA).
Defining ESG investments
To identify suitable ESG investments, portfolio managers assess companies on their ESG credentials, looking at a broad range of criteria.
The environmental (E) aspect focuses on how the business affects the planet through its use of energy, its pollution, and its natural resource conservation. The social (S) aspect addresses the company’s relationships and looks at issues such as employee welfare, employee diversity, and human rights monitoring. As for the governance (G) aspect, this looks at how a company is run and considers factors such as executive compensation, board composition, and anti-corruption measures.
Ultimately, the aim is to invest in companies that respect the environment, care about human wellbeing, and demonstrate responsible corporate behaviour.
Why is ESG investing important for investors?
ESG investing offers a range of benefits.
For a start, it allows investors to align their portfolios with their ethical values and make a positive contribution to the environment and society. By investing in companies that are acting responsibly, investors can actively contribute to the creation of a more sustainable future.
Secondly, it can offer the potential for attractive long-term returns. In the past, it was often thought that investing with an ESG focus meant sacrificing returns. However, recent research has shown that ESG funds can perform just as well as traditional investment funds. Indeed, an analysis of ESG investment product performance by Morningstar in 2023 found that there is no performance trade-off over the medium to long term. Some studies have even shown that a focus on ESG can lead to outperformance, as better management of ESG risks tends to lead to higher operating margins and returns on capital.
Thirdly, ESG strategies can potentially help to lower risk. Companies that have high ESG scores tend to be well-run businesses with lower levels of controversies. And these types of companies tend to be more resilient during market downturns. According to research from Morgan Stanley, when equity markets experienced weakness in 2008/2009, 2015, and 2018, sustainable investment funds consistently outperformed traditional investment funds.
Types of sustainable investments
Those looking to incorporate sustainable investments into their portfolios have many options today including:
- ESG-focused equity funds – With these funds, capital is invested across a range of companies that score well on the ESG front.
- Socially responsible (SRI) equity funds – Socially responsible investing is a form of sustainable investing that involves choosing or disqualifying investments based on specific ethical criteria.
- Impact investing funds – Impact investing is a form of responsible investing that involves investing in companies that are having a measurable positive impact on the world.
- Green bond funds – With these funds, capital is directed towards debt securities issued by governments, corporations, or other entities that are raising money for projects with a positive environmental impact.
- Private equity or debt funds with a sustainable focus – These funds back unlisted companies that are having a positive impact on the world.
The role of ESG investments in a diversified portfolio
Including ESG investments in a portfolio can be an astute strategy.
Not only can they help to align one’s investments with their personal values and beliefs, but they can also help investors build more robust, diversified portfolios.
For many of our clients, those values and principles are shaped by concerns about the future of the planet and the way we treat our fellow humans.
To learn more about how we can help you with ESG investing strategies, get in touch with us today.
BOWMORE FINANCIAL PLANNING
PHONE 01275 462 469
- Bowmore Asset Management Ltd is authorised and regulated by the Financial Conduct Authority.
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.
- The value of your investments can go down as well as up, so you could get back less than you invested. Past performance is not a guide to future performance.
