You know you need to invest. You do know that, right?.
But how can you invest in line with your values and ethics to positively impact the world and not feel like you are becoming rich off things that are damaging the world and society?
That’s why lots of people are now looking at ESG investing.
However, the term ESG can cover several different styles or types of what people might call socially responsible investing. The main ESG strategies are exclusion, engagement, ESG compliant, sustainability-themed, norms-based, best in class and impact.
The article below will dive into the 7 types of ESG investing and what you can do to get started in investing that matches your ethics.
What does ESG stand for, and what does it mean?
ESG stands for environmental, social and governance.
These non-financial factors can be applied to companies to see how they are performing against these metrics.
These factors can be used to review a company’s risk profile and growth opportunities.
- Environment. What sort of impact is the company having on the environment? This could be about its carbon footprints, the waste produced, and the resources consumed by its supply chain.
- Social. How does the company treat its staff, suppliers and the communities it works in. It could also include the diversity of the workforce at all levels, including the board. It could also look at how the company is trying to support positive social programmes in its workplace.
- Governance. This looks at how the company manages itself, including accountability and transparency, how it deals with workers’ rights and executive pay and how the leadership responds and interacts with workers and investors.
As you can see, there is the potential for a number of these areas to overlap and be sat in one or more areas.
What ESG means is that a company is trying to work towards or comply with ESG criteria.
The main purpose of ESG criteria is an assessment of risk and opportunity.
What risk does a company have against
- Environmental factors: is it polluting the environment, and will it get sued for this, or will this cause its workers to get sick
- Social factors: are its social practices likely to cause it trouble in the future, poor pay and working conditions,
- Governance factors: is the way it runs itself full of risk of fraud, poor practices, preventing diversity
What potential opportunities does a company have
- Environmental: being ahead of any environmental laws, moving into new technologies like electric cars that put it ahead of its rivals
- Social: Its social activities make it an attractive company to buy from and do more business with.
- Governance: How a company runs itself means it attracts and keeps the best talent.
Part of the challenge for newbie investors is that ESG, sustainable, socially responsible, ethical and green investing have become interchangeable but can mean different things to different people.
The 7 types of ESG investing
This is where an investor would actively screen out companies that they do not ethically or morally want to invest in.
The typical examples of this are
- Oil and gas – fossil fuel companies
- Medical testing
- Fast fashion
This strategy actually involves buying some of the above companies with the intention of trying to influence and change them to better practices.
So gaining voting rights and voting for or against initiatives you feel the company needs to change.
This means trying to change the company from the inside.
#3 ESG compliant
ESG compliant means investing in companies that have met or exceeded certain ESG criteria/scoring.
So, a company has scored highly against one or all of its environmental, social and governance practices.
It might be here that you only invest in companies that meet one or more ESG score ratings that you are focused on.
#4 Norms based screening
The approach looks at globally agreed standards under the UN, or other world bodies that most people agree are good things to work towards.
These include things like human and workers’ rights, various climate agreements and modern slavery standards.
#5 Best in class
This is where you would be selecting a company that is the best in its class.
This could mean selecting the most environmentally friendly companies as a whole or across specific sectors.
#6 Sustainability themed
This is where you are selecting companies for their impact and sustainability on the world.
A company will often align itself with one or more of the UN Sustainable Development Goals.
This means that they might include or support initiatives to reduce poverty, improve childhood education or provide clean water.
Impact investing is where a company or investor is trying to have a positive, measurable environmental and social impact while making a profit.
Impact investing is the most rigorous of all the potential ESG strategies as it seeks not just to do no harm but ensure it has a measurable positive impact.
Impact investing is often considered to be more focused on solving environmental and social problems rather than trying not to make things worse.
Companies classified under this strategy are also showing a commitment to measure and report on their performance and impact so you can see if they are making any positive change or not.
The pros and cons of ESG investing
The Pros of ESG investing
- It’s a way to try and have a positive impact on the world
- It’s a way to try and align with your ethics
- It’s a way to manage the likely risks and opportunities
- It can get you started investing in the way you would like
The cons of ESG investing
- It can be a more expensive way to invest as more active screening potentially needs to take place
- There is no agreement on ESG criteria, so what you think is ethical is not necessarily what someone else thinks is ethical.
- It can be trickier to choose the most important issue for you.
- You might be narrowing the types of companies you can invest in and become less diversified.
- ESG companies might do better or worse than non-ESG companies.
Why ESG investing is important
ESG investing is important as it is a way to measure a company’s potential risk and opportunities in a changing world.
Environmental, social and governance issues are also increasingly on the minds of investors and consumers, so companies who ignore these might not have a long future ahead of them.
It’s also important as it signals to companies that these issues are important and need to be tackled collectively to solve some of the world’s biggest problems.
Are ESG funds a good investment
Yes, they can be, but you mustn’t forget the principles of good investing.
Just because you think something is a good or ethical investment doesn’t necessarily mean it is.
The principles for successful ESG investing – like all investing
- Manage your swings between greed and fear
- Understand the difference between temporary declines and long-term growth
- Make sure you are globally diversified – not all your money in windfarms
- Do your research to understand what you are investing in – what it says on the tin might not be what is within.
- Keep your costs low – some ESG funds can be more expensive, so something to find a balance with.
Just like any investment, they can have their ups and downs, years when they are the hottest thing and then the next when they are out of favour.
You just need to remember that ESG is about how a company operates and not necessarily about what it is or does in the world.
ESG investing: How can you get started investing
First, you need to look into the 7 types of ESG strategies we have covered above and choose broadly where you sit from 1-to 7.
Impact investing is the strictest of them and only investing in companies that are specifically trying to have a positive impact on the world’s problems.
Any strategy you take will have pros and cons, so just make sure you are aware of them.
The second thing to do is figure out are you going to do this yourself, with someone else like a financial planner or coach or get someone to do it for you like a financial advisor.
Thirdly, look into the platforms available to buy the ESG funds you want. They may include
- Hargreaves Lansdown
- Interactive investor
And finally, decide whether you will invest a lump sum or a regular monthly amount.
Then make sure you keep reading about the principles of good investing so you don’t panic when they go down in value.
Remember, the long-term trend is your friend, not the day to day prices.
Final thoughts: 7 Types of ESG investing
As we have seen with the various types of ESG investing strategies, there is no one size fits all method of investing and aligning that with your ethics and the need to generate a profit
It doesn’t mean that these are exclusive, just that you need to be clear about what you are investing in and just because it is called ESG doesn’t necessarily fit with all your investing goals.
Being clear on the types of ESG strategies there are and which one fits best with you are the first steps in aligning your investments with the impact you want to have on the world.
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References: Types of ESG investing