Investing for a sustainable future

With the upcoming COP27 week from 6th November in Sharm El-Sheikh, there is renewed focus on climate change, as the energy crisis has worsened since the Russia/Ukraine war. This creates more challenges towards decarbonisation in the near-term. Energy will have to get dirtier, before it gets cleaner, which raises concerns about the Government’s commitment to energy transition and Net Zero.

Sustainable investing rightfully gained much attention in recent years, as investors large and small seek to mitigate ESG risk. Furthermore, studies show that ESG score downgrades have a financial impact on companies.

There are a number of ways to invest sustainably whilst maintaining a diversified world equity exposure. To compare the differences, the choice of index is key. Index methodologies range from very simple exclusionary-based approach, to a more nuanced set of filters and screens.

ESG indices typically assess and score company’s environmental, social, and governance risks. Additionally Socially Responsible Investing (SRI) indices screen out companies based on reputational risk criteria. “Positive screening” means applying a best-in-class approach and selecting companies that score better than their industry peers, in a given sector.

How can investors use ETFs to build in a sustainability perspective to their world equity exposure to mitigate ESG risk? We contrast three different approaches:

1. Reduced fossil fuel & reputational focus: the MSCI World Socially Responsible Investing (SRI) Select Reduced Fossil Fuels index approach screens out firms with high ESG risks and also non-renewable energy such as companies involved in fossil fuels extraction and production (coal, oil sands and gas), as well as nuclear power generation and uranium mining. iShares MSCI World SRI UCITS ETF (LSE:SUWG) tracks this index.
2. Values-based exclusions: indices may exclude companies that negatively impact the society and environment by involvement in conduct controversies, vice products, weapons manufacture and nuclear power, such as the FTSE Global All Cap Choice index tracked by Vanguard ESG Global All Cap UCITS ETF (LSE:V3AM).
3. Low carbon and improvers: the FTSE Developed ESG Low Carbon Select index aims to halve carbon emissions and fossil fuel reserves at an index level as well as targeting companies with improving in ESG ratings while excluding weapons and conduct controversies. HSBC Developed World Sustainable Equity UCITS ETF (LSE:HSDS) tracks this index.

When evaluating ETFs for a target exposure, a detailed analysis of underlying index methodology is key. These are three different ways of screening out high ESG risk exposures from your portfolio while staying invested in a diversified range of world equity investments.

Notices

All ETFs mentioned are London-listed ETFs and available on the IG share dealing platform.

Your capital is at risk. The value of shares, ETFs and ETCs can fall as well as rise, which could mean getting back less than you originally put in.

The views and comments are the author’s own and do not constitute a personal recommendation, advice or marketing communication.

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