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🧐 Unpacking the Different Types of ESG Investing 💰

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.

types of ESG investing
Types of ESG investing: Photo by Raphael Cruz on Unsplash

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 means it attracts and retains 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.

ESG investing examples

ESG investing refers to the practice of investing in companies that meet certain environmental, social, and governance criteria. Here are some examples of ESG investing (not a recommendation to buy sell or hold any of the examples just examples):

Investing in Renewable Energy Companies: Investing in companies that produce solar, wind, or other forms of renewable energy. For example, investing in a company like NextEra Energy, which is one of the largest renewable energy providers in the world.

Sustainable Funds: Investing in mutual funds or ETFs that focus on companies with strong ESG practices. For example, the iShares ESG MSCI USA ETF is a fund that invests in U.S. companies that have high ESG performance relative to their sector peers.

Green Bonds: Purchasing bonds that are specifically used to fund projects that have positive environmental benefits, such as clean transportation, sustainable water management, or renewable energy.

Community Investing: Investing in local businesses or community programs that have a positive social impact. This might include investing in a community development financial institution (CDFI) that provides financial services to low-income individuals or communities.

Corporate Governance: Investing in companies that have transparent accounting methods, fair treatment of shareholders, and appropriate executive compensation. For example, investing in a company like Microsoft, which is known for its strong corporate governance practices.

Socially Responsible Investing (SRI): Selectively investing in companies that align with the investor’s values, such as companies that support human rights, fair trade, or do not engage in harmful practices like tobacco production.

Impact Investing: Investing in companies or projects to generate a measurable, beneficial social or environmental impact alongside a financial return. For example, invest in a start-up developing clean water technologies in developing countries.

ESG Themed Index Funds: Investing in index funds that track the performance of a selection of companies meeting certain ESG criteria. For example, the Dow Jones Sustainability Indices (DJSI) include companies that excel in terms of ESG criteria compared to their industry peers.

Investing in B Corporations: Investing in companies that are certified as B Corporations, meaning they meet high standards of social and environmental performance, accountability, and transparency.

Forestry and Sustainable Agriculture Investments: Investing in sustainable timberland or agricultural practices that are designed to be environmentally friendly and sustainable over the long term.

These examples illustrate the diverse ways in which you can incorporate ESG criteria into your investment decisions.

Types of ESG investing
Types of ESG investing: Photo by Markus Spiske on Unsplash

ESG strategies for investors & types of ESG investing

#1 Exclusion.

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

  • Arms
  • Tobacco
  • Oil and gas – fossil fuel companies
  • Medical testing
  • Fast fashion

#2 Engagement

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.

#7 Impact investing

Impact investing is when a company or investor tries 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 committed to measuring and reporting on their performance and impact so you can see if they are making any positive change.

types of esg investment
Investing in a rubbish business: Types of ESG investing: Photo by Vivianne Lemay on Unsplash

The pros and cons of ESG investing

ESG Investing Pros and ConsProsCons
Financial PerformanceOften yields competitive returns compared to traditional investments.ESG companies might do better or worse than non-ESG companies.
Risk ManagementHelps in mitigating long-term risks such as climate change. Also, it’s a way to manage the likely risks and opportunities.ESG criteria can be subjective and may not always accurately assess risk.
Impact on SocietyContributes positively to society and the environment. It’s a way to try and positively impact the world.Not all ESG investments have a direct or measurable positive impact.
Investor DemandGrowing demand among investors, especially millennials. It can get you started investing in the way you would like.Limited options in certain markets or sectors.
Regulatory ComplianceESG investments often align with regulatory trends.Evolving regulations may affect the stability of ESG investments.
Reputation and BrandingEnhances corporate reputation and branding.Greenwashing (misleading claims about sustainability) can be a concern.
Long-term FocusEncourages long-term investment horizons.May not be suitable for investors seeking short-term gains.
Alignment with EthicsIt’s a way to try and align with your ethics.There is no agreement on ESG criteria, so what you think is ethical is not necessarily what someone else thinks is ethical.
Investment CostsIt can be a more expensive way to invest as more active screening potentially needs to take place.
Choice and DiversificationIt 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 invesitng pros and cons

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.

Types of ESG investing
Types of ESG investing: Photo by mk. s on Unsplash

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.

Like any investment, they can have their ups and downs, years when they are the hottest thing and the next when they are out of favour.

You 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, only investing in companies specifically trying to positively impact the world’s problems.

Any strategy you take will have pros and cons, so just ensure you know 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

  • Vanguard
  • Fidelity
  • Hargreaves Lansdown
  • Interactive investor
  • Betterment

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.

FAQ: types of ESG investment

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 and which fits best with you are the first steps in aligning your investments with the impact you want on the world.

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