How can you grow your wealth whilst putting it towards good causes? Ethical investing – often now called ESG investing (environment, society and governance) – seeks to answer that question. In this guide, our team at WMM explains how ethical investing works, its main forms in 2022 and ways that it can integrate into an investment portfolio.
How ethical investing works
Traditionally, companies were mainly selected for their potential to generate strong returns at acceptable risk. In recent years, however, investors have also sought to choose companies which fit with their personal moral code. This might involve focusing on areas such as workers’ rights and climate change, perhaps also avoiding areas like animal testing and arms.
Here, an investor can choose individual company stocks to build a portfolio that meets their criteria. Yet ESG funds are now increasingly available – allowing investors to pool their money into multiple ethical companies. Most of these funds are actively managed, but demand for (typically) cheaper “passive” ESG funds is rapidly outpacing them.
Types of ethical investing
There are various terms used to describe ethical investing, many that are synonymous or describe a specific aspect. “Green investing”, for instance, tends to focus on environmental causes when investing (e.g. carbon emission reduction). Socially responsible investing, conversely, can refer more specifically to concentrating on positive impact within local communities – e.g. ensuring a healthy water supply in developing countries where a company supply chain operates.
This highlights why it is important to not just include an “ESG investment” in your portfolio due to its labelling. Rather, investors should explore the methodologies, priorities and strategies of a fund (and its manager) before committing to it. A fund that merely excludes arms and tobacco from its holdings but describes itself as “sustainable”, for example, may not justify the label if it does not include any sustainable assets.
Ways to adopt ethical investing in a portfolio
Investors will differ on which aspects of ethical investing they feel are most important, and how ESG investing should be brought into their portfolios. There can be a difficult balancing act, as you should not lose sight of the fact that you want to generate a return. ESG investing is not the same as giving to charity.
Fortunately, investing ethically does not need to involve compromising on quality. Indeed, there is some evidence suggesting that ESG investing can generate higher returns. Some investors may want to “dip their toes” into including more ethical investments in their portfolio. Others may want to take a more “radical” approach and focus primarily on ESG investments. Here is an overview of some different ESG strategies to discuss with your financial planner:
- Exclusionary screening. Here, a fund or company is left out of the portfolio if it does not align with the investor’s ESG criteria (e.g. regarding human rights).
- Positive screening. Rather than omitting entire industries – such as fossil fuels – this approach rewards companies that are “leading their peers” on ESG principles.
- ESG integration. A more “balanced” approach to ESG investing, where compromises on principles may be made to achieve higher returns.
- Impact investing. Looks for companies that are focused on specific, measurable ESG “projects” (e.g. building local schools).
- Ownership. Do you own shares in your own company? As a major shareholder, you can help raise ESG issues to the board and bring about some positive change.
Invitation
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This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxfordshire).
