Everything you need to know about ESG investing

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ESG investing is currently a big focus in the financial world, but just what does ESG mean? Why are Impact Investments growing in popularity? And why might they be important to you? 

Our ultimate guide to ESG investing has the answers. 

Who this ESG investing guide is for: 

Our guide to ESG investing is perfect for anyone looking to learn more about ethical investments and to understand exactly what ESG means. If you want to invest in a positive, ethical, and environmentally friendly way, this guide to ESG will help you get started. 

As with all investments, please remember your capital is at risk.

The basics: An introduction to ESG

What does ESG stand for? 

ESG stands for Environmental, Social and Governance. They’re factors you can use to measure how sustainable and socially impactful an investment in a company will be. 

Instead of only looking at the financial performance of a company, ESG criteria look at areas like carbon footprints, workplace rights, business ethics, human rights, ecological impacts, data privacy, labour practices and company culture. 

They’re used by socially conscious investors to evaluate an investment, alongside its potential for good future financial performance.

The three core elements of ESG are: 

Environmental

How sustainable is a company?

What does it do to reduce pollution and protect the environment?

Social

How does a company look after its workers and the wider community?

What does it do to promote diversity and support human rights?

Governance

How does the company conduct itself?

How is its management structured?

How does it handle long-term risks and opportunities?

What is ESG Investing?

ESG investing is where you use environmental, social and governance factors – along with more traditional financial indicators – to decide where and how to invest your money. 

It’s a way to stay true to your values while investing your money for financial returns.  

If you’re thinking about any kind of investment, one of the first questions you might ask yourself is: “where should I put my money?”

A good place to start is figuring out what is important to you – and if environmental, social and governance factors are important to your values and your financial goals, then you could use those indicators when deciding where to invest. 

Remember, it’s still an investment – so you’ll still need to think about your risk profile and the returns when you’re weighing up your choices.

Who is ESG investing for?

You don’t need to be a passionate environmentalist or a vocal advocate for human rights to invest using an ESG strategy. 

If you’d like to see companies do more to protect the planet, you want to make sure companies are taking care of their employees or that their business practices are ethical – then yes, ESG investing is something you could consider. 

But even traditional investors are seeing the benefits of ESG investments. They recognise that the companies who have ethical business practices, who stamp out corruption, promote strong social values and are adapting to deal with environmental changes are the ones who are more likely to be financially successful. 

ESG investing is for anyone:

✔  Who’s socially conscious

✔  Who cares about the environment 

✔  Who has strong values and beliefs 

✔  Who wants to balance risk, returns and their impact

The Rise of Ethical Investments

ESG is a relatively new term in the financial world, but ethical investments certainly aren’t new. 

The practice of ethical or socially responsible investing has been around since at least the 1960s, when some investment managers would actively avoid putting money into tobacco firms, for example, or in businesses associated with apartheid in South Africa. 

In the past, you might have needed to find dedicated ethical investors – those who only specialised in these types of investments. 

But today, ESG investment is growing across the board. A lot of institutional investors and retail investors are factoring ESG into their analysis and their processes, along with the typical financial assessments.

Why? 

Because the world is changing. 

Changing world, changing investment approach

Climate change. Political upheavals. Global health crises. Huge shifts in social attitudes. They’re all part of a changing world. 

The demand for ethical investments is growing because our understanding of the world – and our place in it – is changing. 

We’re changing too. We have a greater awareness of social, environmental and ethical issues both at home and abroad. 

We have different views about money, finance and investments.

A new generation of investors means a new approach to ethical investing  

The Stats on ESG*

  • €120 billion (approx. £107 billion) – Put into sustainable investment options in 2019.
  • $20 trillion (approx. £15 trillion) – The estimated amount that millennials will invest in ESG in the USA over the next twenty to thirty years.
  • $4 billion (approx. £3 billion) – Amount invested in ESG funds in the first three quarters of 2019.
  • 47% – The percentage of 18 to 34 year-olds planning to invest ethically 
  • 67% – The percentage of millennials who see investments as a way to express social, political and environmental values. 
  • 84% – The percentage of investing millennials who are interested in more sustainable options, and any investment that helps solve a social or environmental problem. 

Why choose ESG investing?

The popularity of ESG investing might be rising with a younger generation of investors, but it doesn’t matter if you’re a millennial or not – it’s more about your values and what you personally believe in. 

Investing in companies that have strong ESG ratings (more on that below) is good for society. It’s good for the planet. And it could be good for your wallet, too.

You might choose ESG investing because it aligns with your values and beliefs, because you’re socially conscious or because you see the potential for good returns from good causes. 

You may consider ESG investing if…

You care about the environment 

You might choose ESG investing because you care about the environment. You don’t want to profit from companies promoting deforestation or polluting the atmosphere, but you do want to back those with green initiatives, those who are doing something to help save the planet. 

You believe in fairness and equality 

You might want to focus on ESG investing because you believe businesses need to be more inclusive. You might only want to invest with those who take gender and racial diversity seriously.

You think corporations should be accountable  

You might be considering ESG investments because you think corporations and big businesses should be held accountable. You don’t want to benefit from those companies who might be involved in corrupt practices, or those executives who take more than their fair share. 

ESG investing is all about making the right choice, so if you’re a socially-conscious person, then you may want to consider ethical investing. 

But it might also be about smarter returns too. 

Because the world is changing. Those companies that are changing too – those that are ahead on environmental, social and governance issues – are often the ones who deliver stronger returns. 

There’s more and more research that suggests companies who perform well on ESG factors often perform well financially too. 

Why? 

Because those firms with good management practices are far less likely to be involved in bribery, corruption or fraud that could impact their performance. 

Because those businesses who have a strong record on workers’ rights are far less likely to be involved in worker disputes or strikes that could reduce their economic output.

And because consumers are crying out for businesses to change their practices – and businesses are starting to listen, as collectively, consumers hold the power with their money.

So ethical investments can be like other risk and return portfolios on the market, but with the added benefit of ESG alignments.   

Jargon Buster

  • ESG – Environment, Social and Governance (factors used to measure ethical investments)
  • Ethical investing – A general term used when you’re making investment decisions based on your values, belief and principles.
  • SRI – Socially responsible investing, similar to ESG or ethical investments, but focused more on personal value judgements and negative screening (see below).
  • Impact investing – Investing in companies working to solve environmental or social challenges (like clean water or solar energy). See also Mission-related investing.
  • Mission-related investing – Investing in companies that have a strong mission or focus to make a difference and impact change. See also impact investing.
  • ESG score/ESG rating – A measurement given to companies that weighs up their ESG practices to help determine ethical investments
  • Screening – Positive or negative, screening is the process to add or remove companies from your investment portfolio because they match or don’t match your values
  • Sin stocks – A traditional way to refer to companies that are associated with gambling, drugs, alcohol or weapons manufacturing 
  • Social washing/Greenwashing – Terms used when companies exaggerate or misrepresent their ESG credentials.
  • ESG Integration – An investment strategy that combines your ethical values and principles with ESG data and traditional financial performance indicators – with the aim of generating a good return for your investment.
  • Traditional/Fundamental financial analysis – The way traditional investment opportunities are determined, which usually includes key performance indicators, financial statements, competitors and market factors.

Next steps – essential ESG investing information

Now you know the basics of ethical investing and what ESG is, you might want to think more seriously about whether it’s for you. So you’ll need more information. 

You’ll want to know:

  • Exactly what ESG analysis looks at
  • How to measure how ethical or unethical a company is, using ESG factors 
  • How to find ethical investments – and which approach to take
  • The challenges to watch out for 

What factors does ESG investing focus on? 

Although we can separate many different factors and metrics into the three core categories of environment, social and governance when looking at an ESG analysis, this isn’t always helpful. 

This is because many ESG factors are connected and they don’t always fit neatly into one specific category. 

Take good employment practice, for example. A company with forward-thinking employment policies could positively impact its ESG rating in all three categories because: 

  • Well planned, well-thought employee rules, regulations and support show good corporate behaviour and good governance. 
  • A company that takes the time to care about its employees and offer the help and support they need shows a good social commitment. 
  • Those employment guidelines may include working for home or lift share policies to help employees specifically, but which are also good for the environment. 

But it is still useful to understand all the different factors that might be at play in each category, to see what an investment might be analysed and assessed on. 

We’ve pulled together a list for each. It’s comprehensive, but not exhaustive. It’s also important to note that some of these factors will only be relevant to certain industries. 

There are two sides to every budget. Income. And outgoings.

ESG scores and ratings – adding the factors up 

Individually, those factors don’t really mean much. To understand if a company is following ethical and sustainable practices, you need to add all those ESG metrics together to get a score. 

An ESG score tells you how well a company is performing against the environment, social and governance standards used to analyse and rank it. Some agencies give an ESG score, others detail an ESG rating. 

An ESG score or rating helps you find out which businesses or funds are ethical

But to complicate matters, these rating and score systems aren’t universal. 

For example, rating agency MSCI, published by Morgan Stanley, uses a grading rating system from AAA to CCC – Triple A being the highest rating for those companies who have good ESG standards, and Triple C the lowest for the companies with the worst ESG records. 

Another rating agency, Sustainanalytics, uses a different rating system of 1 to 5, one being negative, 5 being positive. 

Every rating agency has different ESG standards, assessing companies using different data, different artificial intelligence models and different methodologies. It’s worth noting that there isn’t one single source of truth – the data is dependent on the information that the companies choose to disclose, so it can be difficult to get the full picture of what’s really going on within the business.

Why do ESG ratings vary between agencies?

Generally speaking, the divergence in ratings can either come from agencies either having differing definitions of ESG performance, or they measure that performance differently. For example, one agency could look at carbon footprint, pollution records, health and safety and lobbying as part of its ratings scope, whilst another agency doesn’t consider lobbying.

Some agencies also assign more value to certain attributes – for example, they may consider health and safety to be more important than lobbying. This is known as weight divergence.

Equally, ratings agencies may evaluate the same attributes, but using different indicators. For example, if an agency was looking at environmental impact, they may measure it by looking at the business’s carbon footprint. However, a different agency may instead look at its pollution records. So, even though they are both looking at the environmental impact, they are likely to have different assessments.

Claro has partnered up with TruValue Labs to get rich data and insights on impact and sustainability-based metrics across different businesses and industries. We will be measuring the overall impact and sustainability of businesses through a range of Sustainable Development Goals (SDGs), which have been developed by the United Nations. There are 17 goals in total, ranging from Gender Equality to Responsible Consumption, usually covering all the sections we typically see across E, S and G.

The UN designed these goals as a “blueprint to achieve a better and more sustainable future for all”. At Claro, we decided to use SDGs because we see value in people understanding impact and sustainability information in a clear and simple way. Unlike some methodologies that might seem a bit confusing, we see the SDGs as a universal call to action that can be understood by all – whether it’s to end poverty, protect the planet or ensure that all people enjoy peace and prosperity.

How to get started with ethical investments

Now you know how ESG investments are analysed and scored, you might want to think about how to get started yourself.

First, decide what you want to focus on 

There are different types of ESG and ethical investing, so before you jump right in, you should take some time to think about which type of investments might be best for you. 

Start with your values. Think about what’s important to you.

What are your strongest beliefs and principles? Do you want to make investments solely based on them, or do you prioritise good returns on the money you’re investing too? 

Think about issues too. Are there any areas that you want to focus on with your investments? Perhaps clean energy, or new technology? Or maybe the FTSE 100? Or are you more interested in investing based on how companies conduct themselves, the things they say and do? 

Having answers to these questions will help you decide what type of ethical investments you’d like to make.   

Second, find the opportunities that interest you 

Next, you may want to look for those investments and decide on the strategy you’d like to follow. 

For example: 

If you’re passionate about certain issues and have strong beliefs or principles

You might want to look at a socially responsible investment strategy, where you make judgements about investments based on your values, and check that they always align with what you believe in. This is the oldest form of ethical investing. This often involves screening certain stocks like gambling and weapons production, those that go against your religious principles, or more recently, those involved with animal testing, nuclear power and fossil fuels. 

If want to see changes on certain issues or in certain areas

You might focus on impact investing, where you identify companies that are working towards affecting positive change in the world, and can watch those changes come to fruition. This might be those focused on affordable housing, transforming access to education or using technology to improve the availability of clean water. 

If you care about social, environmental and governance issues but you also want to take a more traditional approach to investing 

You might want to continue with an ESG investment approach, sometimes known as an ESG integration strategy. This is where you take a broader approach to your ethical investing, using ESG scores and more traditional financial performance factors to invest your money in ethical companies while also focusing on a good return for your investment.

An ESG investment or integration takes the best of both worlds. It combines your ethical, social and environmental concerns with an investment approach aimed at making you money.

As with all investments, please remember your capital is at risk.

You can find ESG investment opportunities by researching online for what is available. Some fund providers show ESG information in their Factsheets.

The challenges of ESG investing

Finding ESG information can be difficult

Although more attention is being given by investors to ESG factors and more companies are reporting on their environmental and social credentials themselves, finding accurate, up to date ESG information can be difficult. 

Many key pieces of information, like how a company is reducing its carbon footprint or how it treats employees internally, can be kept private. 

Companies can also lie about their ESG achievements, known as greenwashing. Greenwashing is where businesses spend more time and money marketing themselves as being eco-friendly and boasting about their ‘green’ credentials than actually taking the steps to minimise their environmental impact. They might use buzzwords like ‘sustainable’ and ‘organic’, but without actually having anything to back it up. Or, even more concerningly, they could go as far as outright lying about certain areas of the business, such as carbon emissions. 

It’s not always easy to spot greenwashing, but the key is to not take everything you read at face value – take the time to dig a little deeper.

And measuring ESG can be tough

Some ESG factors simply can’t be measured, like the type of relations a company has with its community. 

Some can be, but then it’s difficult to decide how much those measurements are worth. 

For example, we can look at and measure how often a company hires, fires or loses staff – the employee turnover rate. But figuring out how much a high turnover costs a company is more difficult. 

There are no set standards for ESG scores

There might be several different rating agencies scoring companies and investment funds on their ESG credentials, but each uses a different set of standards. 

In practice, this means that one rating agency might give more weight to one social factor, while another thinks a different social factor is more important. One might look at an important environmental factor, another might ignore it altogether. 

It means that ESG scores aren’t black and white. One agency might give a company a very good ESG rating, another might see it as more average. 

You can find out more about ESG scores, ratings and standards on our blog. 

It’s hard to compare ratings between different agencies

The lack of set standards across the industry also means it’s very difficult to compare ratings between agencies. 

When one agency gives one score and another gives a different one, because they use such different methodologies, it’s hard to compare and contrast them. They use different analytical approaches, different sets of data and assign different weighting to different metrics. 

According to an MIT Sloan School of Management working paper, the agreement and matches between five different ESG ratings agencies was around 61%. If you were to compare traditional ratings from agencies like Moody’s Investors Service and S&P Global Ratings, they agree 99% of the time.

Claro has partnered up with TruValue Labs who has a wealth of data on impact and sustainability-based metrics, which will be represented in the form of the 17 UN SDGs across E, S and G.

The future of ESG investing

Despite the challenges of ESG investing, it offers lots of potential. 

It’s a brilliant way to invest your money with the potential of very good returns in an ethical, considered manner. 

A positive way to invest that supports your concerns and beliefs about the environment, society and good governance. 

More and more investors are turning their attention to it because it can be very effective. 

Companies that focus on their ESG credentials are more likely to be sustainable and successful in the long term. That is good for your investments, and potentially offers good returns. However, remember success is not guaranteed and your investments can go up as well as down.

Financial institutions and rating agencies like the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) are working together to form standards for ESG ratings too, which will help bring some uniformity to the industry. 

One thing is for certain. ESG investments are here to stay. 

With the modern world an interconnected, global community – highlighted further by the coronavirus pandemic – it’s clear that financial investments don’t exist in a vacuum. 

We’re all connected. We’re all responsible for this planet, for our society. Companies – and investments in them – are changing to reflect that. 

So the importance, and popularity of ESG investments will continue to grow too.