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The UK has committed to a zero-carbon target by 2050, aiming for a 68% reduction by 2030 (compared to 1990 levels) in the shorter term. Newly-elected U.S. President Joe Biden has also committed to the same target for the USA. Within the investment world, moreover, large asset management firms are trying to meet growing investor demand for environmentally-friendly funds and investment opportunities. In light of the above, what is the current landscape like for ethical investments in 2021? What kind of prospects lie ahead for those looking to increase the “ESG profile” of their portfolio (environmental, social and governance)?
The rise of ESG
To quickly recap, “ESG funds” refer to funds which pool investors’ money into companies which seek to mitigate harm to the environment and positively impact social issues through corporate governance whilst seeking to generate an investment return. Interest in these funds has been steadily rising in recent years, yet took off as COVID-19 ravaged markets in 2020. In the 12 months preceding January 2021, cash around the world held in ESG ETFs (exchange-traded funds) grew by 300% – totalling $196bn (£141bn). The inflows were particularly strong in Europe, running at €45.5bn (double the levels in 2019). Asset managers have taken note and responded with the launch of 86 European ESG ETFs – growing the total to 233; a big rise since 2017, when there were 63.
Despite this encouraging move in the investment world towards ethical companies, ESG funds still remain overwhelmingly “active” rather than “passive”. These types of funds try to “beat the market” by anticipating which stocks will rise/fall, but tend to come with a higher price tag for investors (e.g. trading fees). Of the $1.6tn invested worldwide in ESG, passive ESG products still account for a tiny traction.
The road ahead
Across the world, large fund managers are moving towards ESG. In December 2020, 30 of the most well-known groups established the Net Zero Asset Managers initiative, committing to the net-zero target by 2050. This is likely to put huge pressure on other fund managers to follow suit or risk divestment. However, there are still many obstacles ahead. For instance, it will still be a while before widespread investors can access “portfolio scores” in relation to ESG, and not just financial performance. Also, due to Brexit, the UK is able to side-step the EU’s Sustainable Finance Disclosure Regulation (SFDR) which will require portfolio managers in member states to document sustainability factors for clients. However, it will probably only be a matter of time before the UK faces political pressures to follow suit.
How to approach ESG with your own portfolio
It may be that you are considering ways to increase the ethical/environmental friendliness of your portfolio. There are different approaches which you can discuss with your financial adviser depending on your goals and situation:
- Exclusion. Perhaps the most “radical” approach, here the investor excludes sectors, countries and businesses which do not meet their ESG standards (e.g. regarding human rights). This can be quite limiting, but appeals to some investors.
- Screening. Here, companies are included if they are showing leadership in their sector or industry with regards to ESG, compared to peers.
- Integration. Here, ESG funds and companies are included within existing investments in a “traditional” portfolio based on performance measures and diversification goals.
- Ownership. You could, of course, choose to invest directly in the shares of specific, individual companies and use your voting rights to advance ESG issues/causes. You should consider seeking financial advice if considering this approach, however, as this can expose investors to risk by concentrating too much capital in one company.
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