ESG and Ethical investing - the lowdown
As financial advisers, we regularly talk to our clients about their vision for the future and support them to set goals that are aligned with their values. But did you know that in addition to making lifestyle decisions based on your values you can also invest in line with them as well?
A growing trend among investors worldwide is what is often referred to as ethical, sustainable or responsible investing. In short it means investing your money in companies that are aligned with your principles. For example, this can mean not investing in companies that promote gambling, sell tobacco, weapons manufacturers or companies involved in animal testing.
If you are interested in ethical investing, the first questions that will likely come to mind is – what is my definition of ethical? Where do I draw the line about what to include or exclude from my portfolio?
To make life simpler, it is worth considering starting out with what is known as ESG investing. Here is a quick rundown of what you need to know to decide if ESG investing is right for you.
What is ESG Investing?
ESG investing stands for Environmental, Social and Governance investing and is a framework used by investors and fund managers to assess the likely future performance of a company based on a set of non-accounting criteria. The belief is that the way a company manages these intangible risks and opportunities will affect its brand value, reputation, and operational efficiency.
How are companies evaluated?
Each fund manager will have their own criteria that they use to assess a company’s response to a range of issues, which will typically include:
Environmental factors such as the company’s impact on climate change, energy efficiency, pollution generated, waste management practices, and so on.
Social factors such as how the company treats its workers, working conditions, impact on human rights, workplace diversity, health and safety, and the impact on the surrounding communities; and
Governance factors such as corporate ethics, board diversity and independence, company culture, business conduct (or misconduct), executive remuneration, transparency on tax and business practices, and data security to name a few.
This assessment is typically based on a range of sources of information, including that obtained from regulators, activists, thought leaders as well as the leadership team of the companies themselves.
Is ESG the same as ethical investing?
Yes and no. While both factor in certain ethical principles, purely ethical investing can involve excluding specific companies based entirely on moral values regardless of whether they are a profitable investment. ESG investing on the other hand uses a range of ethical issues to assess their impact on a company’s future financial performance, its resilience and profitability.
Can I apply ESG investing if I prefer to stick with index funds?
Along with the growth of ESG, index funds (also known as ETFs) have also had a meteoric rise in popularity, with many clients attracted to the ease of investing, transparency and low costs that ETFs offer. While there is certainly a benefit to both active and passive investing, if you prefer to stick with index funds the good news is that there is an increasing number of options available, with more and more ETFs offering ethical and ESG investment options.
What are the risks of ESG investing?
Applying an ESG screen to your investments can reduce your exposure to risky investments by excluding companies that have long term sustainability risk. Having said that, the main risk associated with applying an ESG strategy lie in the effectiveness of how the screen itself is applied. This is because ESG screening criteria can differ among fund managers, meaning that some ESG funds may be more effective than others. This risk however is not unique to ESG investing, as each investment fund has their own investment philosophy and criteria which they use to differentiate their approach and achieve their returns.
What are the benefits of ESG investing?
In addition to the potential to reduce portfolio risk, ESG investing offers a way for society to keep companies accountable for the environmental and societal implications of their actions. As more investors look to direct their funds towards ethical investments, this can be a strong motivator to encourage companies to modify their actions and inspire innovation. This means that individual investors can make positive contributions to important issues like global warming and climate change while simultaneously growing their wealth.
Ethical investing and ESG screening are useful tools to help you to effect change and make an impact on a range of environmental, humanitarian and social issues.
However, knowing where to start can be overwhelming. Your financial adviser can be a great source of support and information to help you filter through your options and decide on the strategy that is right for you. If you would like to learn more about ethical and ESG investing, book a confidential chat with us at Serendipity Wealth Advisors.
What you need to know
This information is provided by Serendipity Wealth Advisors. The information contained in this article is of general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regards to those matters and seek personal financial, tax and/or legal advice prior to acting on this information.