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What is ESG investing?

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ESG investing – what is it and how do you get started?

Key takeaways:

  • Assets in ESG investment products have almost tripled since 2019.
  • It allows you to invest in line with your values while also taking returns into account. ESG fund products have shown in the past that they can keep up with the performance of popular stock indexes.
  • Investing in this way requires some research on your part. Get started by using the free in-platform ESG Risk Rating tool.

Whether it’s the shoes we wear, the cereal we eat or the washing liquid we use, by choosing brands that align with our values, we’re able to vote with our wallets for the kinds of businesses we want to support. It can be the same with our investment strategies.

So, how can you get into ESG investing? What are the advantages and disadvantages? Can you really make a decent return when you’re driven by principles?

ESG investing in a nutshell

ESG investing involves selecting investments based not only on potential performance but also on the sustainability i.e. how a company is run and how it treats its employees and the environment.

Because our values, drivers and motivators are different, for some people this could mean avoiding companies producing alcohol or tobacco. For others it could mean shunning businesses involved with fossil fuels, gambling and human rights violations. Or it could mean investing in companies that ‘do no harm’ – i.e. those that treat their employees well or have a low carbon footprint.

In essence, ESG investing can help you build a portfolio aligned with your values on social responsibility. An ESG investor favours companies making a positive impact on people, society and the environment.

The jargon busted: ESG, SRI or impact?

If you’ve explored the idea of investing according to your principles, you’ve probably seen a few phrases thrown around. In addition to ESG funds/stocks, people also talk about ‘ethical investing’, ‘sustainable investing’ or ‘socially responsible investing (SRI)’. You may also have heard the term ‘impact investing’ used in these conversations.

Whenever you see these terms, it’s likely both values and returns are being considered during the investment decision-making process.

"It's frequently noted ESG investing dates back to Methodists and Quakers in the early 1900s – these groups avoided investing in companies involved in gambling, alcohol and weaponry."

What are the different types of ESG investing?

Whatever you call it, this type of investing is based on your values and what you care about. Let’s look at some of these in more detail:

  • Environmental investing: is buying shares from companies that strive not to harm the environment and/or improve it. Companies that produce products or services that cause major harm to the environment – for example oil companies – would normally be avoided as part of this strategy.
  • Social investing: is buying shares from companies that strive not to harm people or society and/or improve it. This typically means avoiding companies that produce/provide alcohol, tobacco, gambling or weapons. It may also involve focusing on companies striving to address social inequalities – including within their own workforces.
  • Governance investing: focuses on companies that are run well. This may reflect the composition of their management or how they treat employees. Firms that use child labour or have a poor compliance reputation may be excluded when investing through this lens.
  • Faith-based ethical investments: those that align with a person’s religious beliefs. It’s frequently noted ESG investing can be dated back to American Methodists and Quakers in the early 1900s – these groups avoided investing in companies involved in gambling, alcohol and weaponry.
  • Impact investing: these strategies generally seek to achieve a particular outcome. A standard ESG fund may, for example, simply look to avoid investing in fossil fuels. An impact fund, however, could look to actively invest in companies that focus on renewable energy production.

"One of the key drivers of growth has been the climate change discussion – especially post-pandemic – which has encouraged people to consider better environmental choices."

How has the ESG investing sector grown?

Between 2019 and 2021, global assets in ESG investment products almost tripled, rising from roughly USD 1tn to USD 2.7tn, according to data from Morningstar. In 2021 alone, more than USD 596bn was invested in these funds. That compares to just over USD 172bn in 2019.​

One of the key drivers of growth has been the climate change discussion – especially post-Pandemic – which has encouraged people to consider better environmental choices.

A survey conducted in 2020 by Boston Consulting Group had 70% of participants saying they’d become more aware of the link between human activity and climate change following the onset of the Covid-19 pandemic. Three-quarters of respondents said environmental issues were as concerning as – or even more concerning than – health issues.

How do you invest sustainably?

Investing with a platform that includes ESG Risk Ratings is one simple way to get started with sustainable investing. An ESG Risk Rating tool does all the hard research work for you, so you can invest in stocks based on how a company is run with no fuss.

CMC Markets has partnered with Sustainalytics, who use a sophisticated methodology​ to rate a company’s economic exposure to Environmental, Social and Governance risk and how well it’s managing those risks. Company ratings are compared across peers and subindustries with fully integrated corporate governance research and ratings.

This information is fed into your investing platform on the individual stock summary card in the form of a clear ESG Risk Rating. The lower the score, the better the rating.

The grey areas of ESG investing

One of the biggest criticisms of ESG investing is that criteria for what is and isn’t sustainable can be vague.

You may, for example, believe a producer of vegan hamburgers is an ethical stock to buy. But what if those burgers have a high fat and salt content? Someone else might take a different view and pass on the stock as a result. A company producing electric vehicles may appear environmentally responsible, but if its manufacturing process produces lots of toxic chemicals and emissions, investors must weigh up the pros and cons before parting with their cash.

It’s also worth noting each ESG fund has different parameters, and these may not necessarily align to your values.

Another misconception to clear up is that ESG portfolios only focus on companies involved in activities like renewable energy, recycling and sustainable agriculture. Many funds will have substantial allocations to popular blue-chip stocks – so long as these have met predetermined sustainability criteria.

"If more people start to invest in sustainable companies, other businesses may start to take note.”

So, does ESG investing work?

Investing sustainably may give you the satisfaction that you’re backing companies with positive ESG factors, such as not polluting, high labour standards, respecting human rights, and anti-bribery/corruption.

As for returns, between 2018 and 2021, we have seen many ESG funds/ETFs have performed similarly to major index ETFs in their respective country. And, over some periods, have even outperformed the major indexes like the FTSE 100 and S&P 500.

Find out more about the CMC Invest ESG Risk Rating Tool


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