How can investors ensure they are making a real difference?
Flick through to any financial pages and it’s hard to miss the buzz around ESG. The term itself has been around for a while and, up until recently, investing this way was a niche for only the most sustainably-minded investor.
Now, however, things have changed. The pandemic has propelled Environment, Social and Corporate Governance to the very top of the agenda. With the spotlight on social responsibility, businesses have been exposed or applauded for their working practices.
Stock markets have reflected this pattern too. While fossil fuel stocks nosedived, ESG funds withstood the COVID19 shock – and continued to perform. This year alone, our medium risk portfolio grew by 5% while the market as a whole plummeted by 3.5%.
So it comes as no surprise that interest around ESG funds has skyrocketed in recent months – driven by none other than the consumer. We are no longer content simply ignoring how our hard-earned money might be funding warfare, lung cancer cases or climate destruction. And, to add to the incentives, returns have been demonstrably better.
This has, however, caused investment managers to jump on the ESG bandwagon. So, how do you separate the green from the green-wash?
Firstly, consider your independent financial adviser carefully. General investment models have not changed with the times, so more general IFAs will tend to refer to ESG ratings during the decision-making process. But, without essential due diligence, an ESG rating alone is a flawed safety net.
For example, a few weeks after BooHoo received an A++ rating from investment rating provider MSCI due to its UK-based supply chain factories, poor working conditions in the same Leicester factories, a coronavirus outbreak and below minimum-wage pay were uncovered by The Times. But based on that A++ ranking alone, twenty funds had invested in the company before this came to light.
So, it’s always more reliable to choose an IFA with specific expertise in ethical investing. They will select funds that actively benefit the people and the planet, considering your specific moral values along the way. Not only that, but you can rest easy knowing that the funds’ policies and practices will be carefully monitored to ensure they continue to meet the highest of standards.
Second, consider the terminology.
As an umbrella acronym, ‘ESG’ covers a huge range of areas. So, while it is a useful catch-all buzzword for the media, it isn’t so useful for the thoughtful investor looking to pinpoint a portfolio’s standards. In fact, the tick-box approach it appeals to simply cannot capture the nuances of an investor’s values and wishes.
In fact, some ‘ESG’ funds include oil companies – especially Exchange Traded Funds (ETFs). And yet for most clients looking to align their money with their values, fossil fuel investment would be a definite no-no. Inevitably, investors find themselves navigating a confusing maze of mixed messages and double standards.
So, is it possible to get caught up in an ESG ‘bubble’?
It’s true that certain stocks with apparently strong ‘ESG’ credentials are experiencing stratospheric price rises. For example, Tesla’s share price has risen roughly ten-fold over the past year which could be due to its reputation as an ESG candidate. But, this is where a good fund manager can help. A smarter investor would not necessarily buy Tesla itself, but might look to invest in the companies that make up its supply chain. And though ESG assets are trading at a premium, the difference is still currently marginal.
Funds actively solving the world’s problems with new technologies – from renewable energy to waste management and sustainable food-chains – offer long-term potential. As long as they innovate, adapt and thrive, investments should continue to perform and avoid bubble territory.
Also, this enthusiasm for ESG isn’t a bad thing. Consumer demand and shareholder power is driving change like never before. Companies that produce or depend on fossil fuels are either starting to exhibit ‘stranded asset’ signs, or are undergoing a transformation to fit with the new normal. For example, Ørsted adapted from an oil and gas company to a 95% renewable energy company and, as a result, their share price has almost quadrupled in the last 5 years.
Ultimately, yes, investors do need to remain investigative. But, with the help of an expert IFA specifically trained in the subject area, it is very possible to make a real difference with your money.
The Path’s founder, David Macdonald, also provided his thoughts on this topic to a recent FTAdviser article which can be found here.
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