In recent years, ESG investing (also called sustainable, ethical or responsible investing) has taken a more prominent role in management and investment decisions. But what exactly does ESG mean, and how does it affect your investment portfolio?
ESG stands for Environmental, Social, and Governance and is a way of measuring and assessing a firm’s sustainability and commitment to ethical practices.
- Environmental: involves evaluating a company’s energy consumption, waste generation, resource utilisation and carbon emissions (among others) and how these contribute to climate change.
- Social: involves examining the relationships and reputation that an organisation builds with individuals and institutions in the communities in which it operates. This includes labour relations, diversity, and inclusion.
- Governance: addresses the internal framework of practices, controls, and procedures adopted by a firm to self-govern, make effective decisions, adhere to legal requirements, and fulfill the needs of external stakeholders.
Image source: https://theconversation.com/
How Does it Work?
For investment purposes, a focus on ESG usually means that the investor considers sustainability and environmental factors when making decisions about what to invest in. This is usually done using an investment filter caller negative screening. Negative screening involves the exclusion of investments that fail to meet specific ESG criteria. For instance, a fund might exclude tobacco making companies and so this fund would not invest British American Tobacco.
Does Sustainable Investing Provide Higher Returns?
As an investor, it’s important to consider how your portfolio aligns with your personal values, such as limiting negative impact on the natural environment, or choosing not to profit from industries such as tobacco and gambling. But it’s also important to ensure that you are getting the returns that will meet your lifestyle and/or retirement needs. The burning question, then, is whether it’s possible to have your cake and eat it – can investors have the best of both worlds and invest in ESG funds that generate good returns?
There have been several studies that compare ESG investment returns to total market investment returns. To date, none of the reports I have read give a definitive answer one way or the other. Some reports suggest that by investing in ‘the most sustainable companies of the future’ that investors have received higher returns than the broader market. While other reports have concluded that not capturing returns of mining, alcohol and tobacco companies has resulted in lower than market investment returns.
How can I Invest Sustainably?
Ultimately, each of us should consider our own personal and investment objectives before making ANY investment. ESG definitions vary from fund to fund so it is important to carefully read the relevant Product Disclosure Statement (PDS) to ensure the ESG screens being used align with your investment preferences. There are many ESG investments readily available to retail investors.
Please contact me if you would like to find out how to invest in sustainable investments.
