Are there any financial benefits to ESG investing?

Environmental, social and governance (ESG) is an increasingly popular investment strategy. This is an ethics-based approach to investing, where investors seek out only those investments which will have a positive impact.

Wanting your investment portfolio to be good for the world doesn’t mean you have to sacrifice decent returns. ESG investing can be just as profitable as non-ESG investing, if you manage your money well.

What is ESG investing?

ESG investing involves applying a sift criteria to your investments to bring your portfolio in line with your personal beliefs.

There are three main criteria for an ESG investment:

Environmental factors

Is the investment ‘green’ and environmentally conscious? This can involve committing to reducing wastage, setting out plans to increase renewables use, or a pledge to reach net zero carbon emissions soon. This may also involve investing in clean energy companies, or companies which have made a commitment to do environmental good.

Social factors

Is the business ‘giving back’ and considering – or mitigating – its impact on society at large? This may involve taking a strong stance on labour or human rights issues, as well as carrying out good works in the countries or communities in which they operate.

Governing factors

How is the organisation run and what is their approach to corporate governance? Look for evidence of diversity in the workforce, and equal opportunities for all genders to progress. This is particularly important when it comes to upper management and the executive committee, who tend to have most say over how the business is run.

Is ESG investing profitable?

While ESG investments may make you feel good about your money, no savvy investor willingly enters into a new investment expecting to lose money. The same is true for ESG investments.

Every investment carries a certain amount of risk and ESG investments are no exception. However, there is a school of thought which believes that the sort of company which is prepared to work hard on its ESG credentials is also the sort of company that understands the importance of making responsible, long-term choices. This is an attractive quality for any would-be investor.

There is also an economic angle to ESG investing. Climate change is an existential challenge that will affect every company on the planet. Rising temperatures and extreme weather conditions will have a disproportionate impact on some sectors, for example agriculture, construction and tourism. But companies with strong ESG credentials are demonstrating an inherent awareness of these future risks and can take early action to offset them and survive the economy of the future, making them more attractive long-term bets.

Furthermore, as more and more countries pledge to become carbon neutral, there is a growing demand for green products and clean energy. Companies specialising in these areas are likely to do well in the future, as well as being good ESG choices in the present.

How do you choose an ESG investment?

You can apply ESG investing principles to any type of investment, but a good starting point is to look at stocks and shares investments and funds, including exchange traded funds (ETFs).

There are two ways to approach choosing ESG-friendly stocks and shares investments:

• Positive screening involves picking businesses that are actively adhering to ESG principles, such as those that deal with clean energy, agriculture, or renewables
• Negative screening is the inverse, eliminating options due to their exposure to contentious sectors such as fossil fuel, tobacco, or weapons manufacturing

ESG ratings agencies such as Sustainalytics contain some useful guidance and analysis on how ESG-friendly certain companies are, and this can be a useful tool when you are trying to create an ESG-forward portfolio.

When you invest in ESG funds, the fund manager does all this hard work for you. ESG funds and ETFs offer instant diversification across a range of investments which have been carefully chosen based on their ESG criteria.

ETFs tend to be cheaper than mutual funds as they are not actively managed by a team of professionals, but rather use an algorithm to replicate the performance of an index (a collection of like stocks and assets).

Ultimately, any well-balanced and diversified portfolio of investments should be capable of delivering financial benefits in the form of dividends or annual returns. Whether or not the portfolio is ESG-driven is more of a preference than an obstacle.

As always, make sure you are making financial decisions in line with your individual risk profile, and do your due diligence before committing any money. Treat your ESG investments just like any other investments and there is every chance that you will be able to maintain decent returns, while keeping your conscience clean.