Introduction to ESG investing
Ethical investing is not a fad. It is becoming increasingly mainstream with figures from the Global Sustainable Investment Alliance showing global sustainable investment topped $30trn in 2018.
Given that regulatory and political pressure is helping to push the environmental agenda, anger is growing over the gap between executive pay and that of ordinary workers, and shareholders continue to count the cost of corporate scandals, all of us need to start thinking hard about these issues.
Once seen as a trade-off between your conscience and your wallet, the good news is there is evidence to demonstrate that including environmental, social and governance (ESG) factors when investing can help boost long-term returns.
For example, the MSCI KLD 400 Social index, focusing on 400 US firms which score highly in ESG terms, has generated annualised returns of 9.8% over the last 25 years against 9.6% for a wider universe of US stocks.
As emerging markets investment guru Mark Mobius, who runs the eponymous Mobius Investment Trust (MMIT), says: ‘By taking ESG factors into account, investors can significantly reduce the risk profile of their investments, which over the long term not only translates into positive risk-adjusted returns, but also positively impacts all stakeholders.’
HOW TO FIND SUITABLE INVESTMENTS
One problem for an investor looking to navigate this emerging space is that it isn’t particularly well defined. Terms like ‘green’, ‘ethical’, ‘ESG’, ‘sustainable’ and ‘impact investing’ are often used interchangeably.
Less scrupulous companies and asset managers have taken advantage of this fuzzy picture by engaging in ‘greenwashing’ – making unsubstantiated environmental claims for their products or services.
ESG IN SUMMARY
– Climate change risks
– Raw materials and water scarcity
– Pollution and waste innovation, clean tech, renewable energy
– Employment policies and industrial relations
– Product and service liabilities
– Treatment of customers
– Impact on communities
– Shareholder rights
– Executive diversity
– Business ethics
– Scrutiny of key directors
But Shares is here to help. In this two-part series we will examine the ‘E’, ‘S’ and ‘G’ of ESG in turn as well as producing our own ESG portfolio of stocks and funds to help spark investment ideas.
While there are clear differences between all three areas, they are often interconnected. For example, BP’s (BP.) Deepwater Horizon rig explosion and subsequent oil spill in the Gulf of Mexico was most obviously an environmental issue but it also had a significant social impact, given the employees killed and the communities affected by the spill, as well as having governance implications thanks to management failings in the run-up to the disaster.
The ability to tap into ESG trends has been made easier as index providers such as MSCI and FTSE Russell have come up with relevant indices such as FTSE4Good and FTSE All-Share ESG.
In some cases, these involve filtering out so-called sin stocks – think arms manufacturers, tobacco stocks, gambling outfits and booze producers – but in others the weighting of shares in the index is determined based on ESG criteria. Investors might be surprised to learn, for example, that Royal Dutch Shell (RDSB) is still the biggest stock in the FTSE All-Share ESG index.
And in recent years a more active approach has developed in the form of impact investing, directing investment towards companies that actively do ‘good’.
PART 1: We look at ‘E’ and ‘S’ from an investment perspective. This week’s magazine also includes a look at the most popular ESG exchange-traded funds.
PART 2 (published on 27 June 2019): Why ‘G’ is important to investors. We also reveal our top ESG picks and create an ESG portfolio.