How to identify an ESG-forward investment

ESG is often used as a catch-all term to cover any type of green or socially conscious investment. But at its core, ESG represents three issues: environmental, social and governance.

When we talk about ESG investing, we are talking about investing in the stocks and shares of companies which meet a certain standard when it comes to implementing ESG processes. This may include a pledge to become carbon neutral by a certain date; a plan to give back to the local community, and a promise to be completely transparent about the company’s internal processes and finances.

ESG-forward investing has become increasingly popular in recent years as a growing number of investors seek to do good with their money by choosing investments that align with their personal values.

According to an analysis by Bloomberg Intelligence, the value of ESG assets passed $35 trillion (trn) in 2020 and could reach $50 trillion by 2025. The ESG market is booming, and there has never been more choice for ESG-forward investors. So how do you identify an investment that is truly ESG-friendly, and not merely paying lip service to the cause?

Verify the firm

The first thing you should do when considering a new investment is Google the company. You should be able to find an independent record of the firm, as well as the company website and any recent news about its activities, ESG or otherwise. Look at the track record of the company and focus especially on what it has already done to improve its ESG credentials.

If it is listed on a stock exchange, all the better - this tells you that the company is overseen by the regulator and is subject to public scrutiny, which will make it easier to track its ESG performance.

Check out their rating

In the absence of a dedicated ESG regulator, a number of ratings agencies have emerged to assess the ESG credentials of any publicly listed company, security or bond and assign them a rating. The two largest ESG ratings agencies are MSCI and Sustainalytics. However, ESG rating services are also provided by Bloomberg, FTSE Russell, CDP Climetrics, Moody’s and S&P Global.

Understand the criteria

Each ESG ratings agency will have its own definition of ESG and its own set of rules for an ESG-friendly investment. It is important to familiarise yourself with the small print to ensure that their ESG criteria matches up with yours.

For example, some analysts consider oil and gas companies like BP and Shell to represent good ESG investments, due to their large-scale investment in green energy solutions. However, other investors may be completely unwilling to invest in these companies due to their poor environmental history and the fact that they continue to mine for fossil fuels.

Invest in an ESG fund

When you invest in a fund or an exchange traded fund (ETF), you are investing in a bundle of stocks and shares which share some common characteristic. In this case, they would all meet the definition of being ESG-forward investments.

Choosing an ESG-themed fund means that you are outsourcing the job of finding individual ESG-friendly stocks and shares to a fund manager. Again, make sure you read the fine print to ensure that your definition of ESG lines up with the fund managers. Alternatively, if your values match with one or more of the ESG ratings firms listed above, you could choose to invest in an ETF which is linked with their own indices.

Look for solutions

Any company can make a statement saying that they are going to plant a million trees, but that doesn’t mean that they will do it. It is your responsibility as an ESG investor to make sure that these are not empty words. Look for evidence of change at the firm. This could be as small as installing a new recycling system or installing electric vehicle chargers at the staff parking lot.

As a shareholder, you are entitled to attend annual general meetings and to pose questions to the executive management, and this is a great way to hold companies accountable to their own ESG goals.

Don’t overlook the returns

It makes sense that some companies will see their stock price stall while they implement large-scale ESG change, such as switching to green energy from fossil fuels. However, this doesn’t mean that you should settle for negative returns on your ESG portfolio.

Your investment portfolio exists to make you money, and if your existing ESG investments are loss-making, it may be time to switch it up. There are plenty of ESG options on the market, so it is only natural that some will do better than others. Keep an eye on your portfolio and don’t feel guilty about moving your money from one firm to another in the interests of preserving your capital so that you can continue to support ESG investments.