It isn’t always easy being ethical and green, especially when it comes to environmental, social and governance, or ESG, investing.
The European Union introduced its Sustainable Finance Disclosure Regulation last year, making asset managers supply detailed disclosures about the ways in which their investments and portfolios apply sustainable policies.
However, there is currently no standardised definition of ESG investing in Britain.
The Financial Conduct Authority is consulting on set rules for labelling sustainable investment products to avoid misselling – and this may help prevent greenwashing, where funds aren’t as climate conscious as they claim.
In the meantime, there are steps you can take to check how ESG-friendly your investments are…
Decide your investing beliefs ESG and ethical investing may mean different things to different people. Some may only want to avoid certain companies, such those involved in fossil fuels or “sin stocks” such as alcohol, gambling, tobacco, adult entertainment or weapons.
Others may be happy to invest if it is clear that their money is being used to shift policy.
The environmental aspect is just one area of ESG and investors may also want to focus on companies with a positive benefit for society or strong governance.
“The key consideration for investors is how can they ensure their values and sustainable preferences are reflected in their fund selection, making sure their portfolio matches their preferred outcome,” says Cat McInally, ESG investment expert at Pru.
“Do you simply want to avoid companies that cause harm to the planet or would you like to invest in areas that seek to improve the planet not only now but for future generations?
“Assessing a particular investment’s suitability will always be based on individual needs, preferences and risk appetite. However, when attempting to meet your ESG objectives it’s important not to lose sight of your investment objectives.”
Be wary of fund labels ESG and ethical funds can come in a range of guises and there are thousands of funds with labels such as ethical, sustainable, responsible, stewardship, ESG, positive impact, climate, green, climate or social. But experts warn that fund titles can mean next to nothing.
“From our research some funds without any ESG branding show better ESG integration than some funds specifically marketed as such,” says Louisiana Salge, senior sustainability specialist at EQ Investors.
“It is crucial to cut across messaging and analyse the fund investment process, the team’s philosophy, its resources and oversight, and dig into underlying holdings, to really get security over a fund’s objectives.”
ESG ratings Most funds are given sustainability or ESG ratings provided by data and research firms such as MSCI and Morningstar.
They dig into a fund’s underlying portfolio using publicly available data as well as information that companies provide to assess climate risk and sustainability.
For example, Morningstar provides a sustainability rating for a fund based on how well the portfolio holdings are managing their ESG risk relative to their peer group.
It also provides scores for environment, social and governance factors. These scores can give you an indication of how ESG-friendly a fund is so you can compare with others and decide where to invest.
ESG ratings do have their limits though. The rating given for a fund represents the overall scores of the underlying companies.
But it can depend on how much information a company provides to the agency and the factors used to score each sector.
The current lack of standardised ESG reporting data means the ratings can be different and inconsistent depending which provider is used.
There are tools that let you do your own research into the underlying companies in a fund.
The Sugi app uses ESG data from S&P Global-owned Trucost to check and compare the carbon impact of funds and individual shares.
It explores a company’s business activities, electricity use, supply chain and customer behaviour and equates an investment’s carbon emissions to chopping down a number of trees, to illustrate the impact of where your money is invested.
Morningstar also has a service called Sustainalytics that lets users view a company’s ESG risk rating and how it compares with its rivals.
Companies are scored from zero to 40, with the highest score reflecting larger risks.
Rather than checking on individual companies, the Fund EcoMarket website lets users search for funds based on individual ESG factors.
You can filter and assess funds based on environmental, social, governance and ethical standards and also dig deeper into individual themes such as human rights policy, or exclude banks, tobacco or gambling firms.
Fund documents Not all fund managers will rely solely on ESG ratings. Many asset managers will have their own sustainable investment or ESG strategy that will give you an idea of their approach.
For example, Jupiter regularly monitors and publishes the impact of its Global Sustainable Equities Fund.
Its 2020 report said the portfolio had helped create 875,000 jobs and saved and treated 100bn cubic metres of water, enough to support 1.9bn people or 24 per cent of the global population.
An asset manager may also have an engagement, responsible investment or stewardship report that shows how active it is when it comes to ESG. It may show how a fund manager voted on key issues such as executive pay as well as any shareholder pressure they exerted.
This shows that a fund manager is actively monitoring how a company behaves and is trying to influence change rather than just following generic ESG ratings.
For example, BMO Global Asset Management makes its voting record available online and its latest responsible investing review shows it voted against 92 management resolutions, such as the re-election of directors, at companies in the financials, oil and gas, utilities and mining sectors, due to inaction over climate change.
Its engagement achievements included getting Facebook to set up a board to function as an independent body to oversee content moderation.
“Documents on a fund manager’s website will give you a good overview of their approach and top holdings, including how green or ethical they really are,” says Rebecca O’Connor, head of pensions and savings at interactive investor.
“You might not have heard of some of the companies that funds invest in but good quarterly and annual reports will give you a bit of information about what they do.”
Prepare for contradictions Ms O’Connor adds that until there are clear rules on sustainable labelling, investors may have to compromise.
“You will want to keep that pinch of salt handy, but also accept that in an imperfect world, even the very greenest of green funds might not be free of contradiction,” she says.
“Electric vehicle manufacturers are likely to be found within them, for example, and yet these do use natural resources in their production.”
Considering ESG financial factors is one thing, but some investors may want to know how sustainable their adviser, fund platform or the actual fund manager is.
“Areas to consider could be, whether the firm itself has assessed the carbon position of suppliers or their own carbon footprint,” says Noreen Siddiqui, digital and policy executive at The Investing and Saving Alliance.
Advisers and asset managers can show their commitment by getting B Corp approved, which is an accreditation that measures a company’s social and environmental impact.
Advisory firms with B Corp accreditation include impact investment specialist Path Financial as well as Coutts.
There are other groups that providers may be signed up to.
For example, Royal London and Scottish Widows are among 53 asset managers that have signed the Paris Aligned Investment Initiative to commit to net zero alignment by 2050.
The United Nations also has its own principles for responsible investment – which fund groups including Aviva Investors and Henderson are signed up to – and demonstrates a commitment to ESG issues.