Investing for the future has taken on new meaning in this world of climate emergency, the continuing Covid-19 pandemic, and our growing awareness of how our actions might affect current and future generations. Environmental, social and governance (ESG) concerns now underpin many investment strategies, with the goal of minimising harm to the world and its people while also generating returns.
Investing in line with ESG practices is a rapidly growing area of the investment fund market. UK investors transferred almost £1bn a month on average into responsible investment funds in 2020. By the end of September 2021, the figure was £1.6 bn, up to two-thirds of total net retail fund investment in that month.
UK investors now have £85bn in responsible investment funds. Between September 2020 and September 2021, the sector saw 87% growth (versus 17% across funds overall), according to the Investment Association (IA). So why now?
Three main factors are behind the move to ESG in the past few years:
- a bigger role by organisations such as the Principles for Responsible Investment;
- an improvement in ESG performance data and investor tools; and
- demand from ‘millennial’ investors, now aged 25 to 41, mid-career, and inheriting the reality of climate change and social unrest (87% of high net worth millennials invest based on a company’s ESG record).
In the last year, the Covid-19 pandemic and the COP26 summit in Glasgow have both led to greater interest in the responsible investment agenda.
Ethical investing was once positioned as a choice of principles over returns. A shift in global policy and advances in technology mean responsible funds now consistently outperform non-ethical equivalents. So, one of the traditional arguments against investing with conscience has all but disappeared.
Analysis of funds covering 23 comparable sectors found in the 12 months to 1 July 2021:
- Ethical funds had produced an average overall return of 19.87%.
- The average return of funds outside the ethical category was 17.89%.
- At a sector level, ethical funds outperformed on average in 13 of the 23 sectors.
Defining ESG investment
ESG investing is about choosing to consider the treatment of the planet, people and management structures in order to receive financial returns in a way that is aligned with personal ethics and concerns about the world. This may mean:
- avoiding certain sectors;
- excluding specific companies; or
- picking a theme with personal importance and investing in projects trying to achieve particular goals or change.
ESG investing lets investors align the way they use their money with their principles, often as part of a lifestyle of ethical consumerism that considers the supply chain of everything we use, from plastic waste to modern slavery.
Global sustainability challenges are forcing us to rethink traditional ways of working and living. Companies that once looked like solid and stable investments now face new risks to their profits, including from:
- food shortages;
- rising sea levels and floods;
- conflicts over resources and land;
- data privacy
ESG investing is considered a way of future-proofing returns by investing sustainably, choosing industries concerned for both people and the planet, in order to make long-term profits.
Example: Cleaner energy electric vehicle (EV) sales are expected to grow globally by 27% a year between now and 2030. Add in remote updates to EV functionality and entertainment, and investors get dual returns: consumer demand for less harmful products, and software subscription deals
Matching investments to your values means deciding what is most important to you. You may need to compromise to achieve all your goals.
The pandemic has made a larger number of investors look at ESG criteria more closely in the context of intergenerational planning and wealth transfer. In a recent survey from Prudential, 61% of participants said they now care more about the environment and the planet than they did before Covid-19. One in five are more worried about ESG issues now they have children or grandchildren.
The report found an increased appetite for ESG investing among:
- 60% of millennials;
- 44% of Gen X;
- 35% of baby boomers; and
- 45% of all investors now only want to invest in sustainable companies and funds.
However more than a third (36%) of UK adults admit they do not know where their current investments, including workplace and private pensions, are invested.
While interest in ESG investing has increased across the board, a generational divide exists over priorities when it comes to choosing investments. Climate change is a more pressing issue for older high net worth individuals, with 55% ranking it their top ESG issue. Social and governance issues ranked lower; only 9% put diversity among their top three ESG concerns.
Younger investors in the 18 – 34 range, however, prioritised social issues.
- 45% said diversity should be companies’ top priority;
- 64% judged companies by their responses to Covid-19; and
- 60% were concerned by unequal financial and social hardship caused by the pandemic.
This divergence of opinion in ESG investing has the potential to cause friction for intergenerational financial planning. A good financial planner can guide you on how best to find compromise for children or grandchildren.
While ESG investment is currently experiencing a positive surge, as with every strategy, there are some key issues that investors should bear in mind.
To cash in on the ‘green pound’, and jump on the bandwagon of demand for ethical investments, some companies are rebranding as ESG-focused in a way that’s not entirely honest.
Some ESG funds take a liberal view of what they allow to make it easier to achieve returns. This ‘greenwashing’ can make it hard for ordinary investors to choose genuine ESG investments.
Greenwashing can be cynical marketing, or it can be an oversimplified view of a company or sector that fails to take into account hidden ESG risks. Examples include:
- Fishing, once seen as ‘green’ versus meat, is the largest contributor to ocean plastic.
- Soybeans are the second largest driver of deforestation after cattle, a fact largely hidden from investors in ETF indexes.
- The Australian government found modern slavery of Uyghurs in the supply chains of at least 82 well-known global brands.
Remember, just because a company, project or fund is marketed as ESG or ethical or sustainable doesn’t necessarily mean it will turn a profit or achieve anything worthwhile.
How we can help
When researching ethical investment funds for client portfolios, we believe in asking the same clear-headed questions of an ethically focused fund as any other potential investment:
- What is it doing better than its peer group?
- What growth has it achieved and what is it doing to achieve more?
- What problem is it solving and how is it measuring its success at that?
- Is it good value for money?
At FAS we can help you to understand how to translate the values that are most important to you into a suitable ethical investment portfolio that reflects your principles and financial goals.
So, if you wish to create a financial plan based on your wishes to build and pass on long-term, sustainable investment returns to your children and grandchildren, speak to one of our experienced financial planners who can help you to embrace the world of ethical investing.
If you are interested in discussing the above with one of our experienced financial planners, please get in touch here.
The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.