Environmental, social and governance (ESG) investing is quickly becoming a popular option for many, but it is a nuanced and fast-evolving area. Louie French, Sustainable Portfolio Manager at Law Society strategic partner Tilney, explains how you can get started.
Climate change is one of the biggest challenges of our day and we are nearing the limits of our ability to mitigate its impact.
Most of us now recognise the significance of this and, alongside commitments by nations, governments and industry, are on our own personal journey to make changes to the way we live our lives. As well as switching energy suppliers, opting for more plant-based food and getting on our bikes to help the planet, the impact of our investments – both positive and negative – is an area of increasing attention and activism, as we become alert to the profound difference we can make through our investment choices.
The sums all of us collectively have invested in the UK – not to mention worldwide – are vast (UK occupational pension funds alone had a market value of £2.2 trillion at the end of 2019, according to the Office for National Statistics), so where we elect to invest our money can make a significant difference.
And momentum is building here, as both institutional investors and individuals choose to move their funds, from oil and gas, for example, into more sustainable alternatives and companies underpinning the move to a low carbon world.
While the motivation of many is to save the planet, it also increasingly makes sound investment sense. As an example, if global warming is to be restricted to 2 degrees centigrade, many fossil fuel reserves can never be used and so have no value – they will become ‘stranded assets’. This applies as well to infrastructure such as power stations, pipelines, chemical plants, cement and transport. Increased legislation can also have an impact on companies through, for example, the levying of taxes on carbon producers.
Against this backdrop, recent movements of money into what are commonly referred to as ESG (environmental, social and governance) assets have been quite staggering. Data from Calastone estimates that ESG funds have taken US$84 out of every net US$100 flowing into equity funds in the last two years, a total of US$15.1 billion out of US$18.1 billion. And, according to Morningstar, by the end of 2020, a total of US$1.6 trillion was invested globally in ESG fund assets.
If you want to put the fight against climate change at the heart of your investments, as our clients are increasingly choosing to do, where do you start? After all, this is a highly complex, nuanced and fast-evolving area.
Language and methodology
Getting to grips with the options and familiarising yourself with the jargon is an important step.
As often happens in rapidly changing environments, the language around sustainable and responsible investing has yet to establish itself and the absence of standard definitions can confuse. Differing methodologies also make it tricky to compare investments, let alone make informed decisions.
Thankfully, this is changing. The United Nations’ 17 Sustainable Development Goals for 2030 set out how to achieve a better and more sustainable future. They cover issues such as the environment and poverty and allow for greater reporting of investment impacts beyond financial returns. In the EU, the Sustainable Finance Disclosure Regulation aims to improve reporting by fund managers and ensure consistent use of definitions and data to make comparison easier. The EU’s Sustainable Taxonomy will also help standardise industry definitions.
With so much momentum behind sustainable initiatives, unfortunately, ‘greenwashing’ is rife too. This is where a business or investment claims to be greener than it really is.
Think about your own values
There are many different approaches to investing in this part of the market, so it’s important to think about your own values and what is right for you. As an example, some investment funds choose a ‘best-in-class’ approach, which means they may include an oil company that has better ESG credentials than its peers. And others include mining companies, which on the one hand are fossil fuel extractors, but on the other are mining the likes of lithium, which is an important material for battery technology.
When you’re choosing investments, make sure you understand what you’re getting so you’re not inadvertently investing in something that is personally unacceptable to you.
Different ways to invest
Many professionals have sizeable assets in workplace pensions, so if your pension provider offers sustainable options, this could be an easy first step. Self-invested personal pensions are also useful for those wanting to build a ‘green’ pension portfolio, because they provide the freedom to pick your own investments. Beyond pensions, a stocks & shares ISA or investment account is all you need to get started.
Funds are a popular choice because they provide access to a wide choice of investments from around the globe and can help build a diversified portfolio. With actively managed funds, you also benefit from the expertise of a professional fund manager. Some people do prefer equities, building a portfolio by investing in the shares of individual companies, but bear in mind that time and detailed knowledge are often key to success here as they are more volatile. There are also an increasing number of ready-made investment portfolios available. These are made up of a range of sustainable investments.
Sustainable and responsible glossary
The different investment approaches
Ethical – this approach focuses on aligning your investments with your ethical principles. For example, you may consider tobacco companies unethical, so you would exclude them from your portfolio.
ESG – here, environmental, social and governance factors are taken into account alongside financial returns.
Sustainable and responsible – ESG factors and themes are incorporated to focus on companies that can grow sustainably over a long timeframe.
Impact – the intention here is to make an impact through investments alongside a financial gain.
Common investment processes
Investment funds in this part of the market can have very different investment processes.
Screening – here, a fund manager will go through a benchmark such as the FTSE All-Share and remove those companies that don’t fit with its ethical criteria.
Best in class – the fund manager will pick those companies in different classes that have the best ESG policies so, for example, they could choose an oil and gas company with better ESG credentials than its peers.
Engagement – shareholder influence is used to persuade companies to adopt better policies while enhancing shareholder value.
How Tilney can help
Of course, you don’t have to choose and manage your own investments. An investment manager can work with you to build an investment portfolio that aligns with both your values and your objectives and then make day-to-day investment decisions on your behalf.
Tilney has been successfully managing ethical and sustainable investment mandates for more than 15 years and has a dedicated central investment process for ethical and ESG screening. We are a signatory to the United Nations Principles for Responsible Investing and, in 2021, won the Best ESG Investment Strategy Award at the City of London Wealth Management Awards.
We offer a sustainable managed portfolio and can also build a tailored portfolio for you. If you’d like to speak to an expert, we offer free consultations, which you can book online or by calling 020 7189 2400. Through Bestinvest, part of our wider group of companies, we can also cater to those wanting to choose and manage their own investments.
The value of an investment may go down as well as up, and you may get back less than you originally invested. Please note that some ethical funds may, by definition, have a limited investment universe; this may affect performance.
This article does not constitute personal advice. If you are unsure as to any course of action, please talk to an adviser.
Issued by Tilney Investment Management Services Ltd. Authorised and regulated by the Financial Conduct Authority.
Tilney is a strategic partner of the Law Society. Find out more