ESG investing is booming. But what is it?

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Investing and religion rarely mix. However, in the summer of 2018, the Church of England hit the headlines when it announced it would sell its investments in oil and gas companies that fail to do enough to tackle climate change.1

The symbolic move by the Church’s deliberative and legislative body (known as General Synod) is a small part of a much bigger trend. Investors around the world are increasingly insisting the companies they invest in are good to the planet and to people.

In the past you might have heard this type of investing referred to as green, environmental, sustainable or socially responsible investment. Today many use the catch-all term ESG, which stands for environmental, social and governance.

Why now?

Global recognition of ESG issues, driven by interest in much-discussed topics like global warming and gender diversity, has led to a major shift in investor attitudes. It used to be that adhering to ESG principles was a nice to have; today it is considered a must have.

The rationale behind ESG investing is multi-faceted. In some cases it involves screening out companies that fail to meet basic standards on, say, workers’ rights and the environment. In others the aim is to exert positive influence by engaging with companies and encouraging best practice.

On the one hand, it can be about grasping opportunities that are emerging thanks to the development of new technologies: for example, the evolution of electric vehicles. On the other hand, ESG strategies might aim to insulate investor portfolios against the predicted decline of polluting companies.

What about returns?

Some sceptics have suggested that adhering strongly to ethical values could hamper investment performance. However, there is mounting evidence that ESG investing is not just good for the planet and society, but also good for investors.

In a recent study, companies that adhere to high ESG standards were shown to be more profitable and have higher dividend yields.2 These companies were also considered better at managing risks.3

According to BNY Mellon boutique, Newton: “Academic and industry research highlights not only that companies with positive ESG credentials perform better but also that those companies with the worst ESG scores are more likely to have below-average financial performance.”

Becoming mainstream

Still, investors need to tread with care. ‘Greenwashing’ was a term coined in the 1980s to describe companies that mislead the public – via media and advertising – about their environmental credentials.

Today, thanks to growing investor and consumer interest in environmental matters, companies are even more aware of the benefits of presenting their products or services as green or sustainable. Whether a company really ‘walks the walk’ often requires in-depth knowledge and extensive research.

One thing is very clear though: ESG investing is here to stay and fast on the way to becoming mainstream. And according to many in the investment community today, ultimately such factors should be part of good risk management and not just something of special interest to investors with strong principles.

1 BBC: Church of England threatens oil firm crackdown, 9 July 2018.

2 A dividend yield is the income return received by a holder of company shares.

3 Forbes: Why does ESG matter? Key items for investors to consider in 2018. March 2018.

 

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