ESG investing provides strong returns

But recent performance data from Morningstar pours cold water on such claims.

The data – as at July 26 2019 – showed that the top three performing ESG funds all gained north of 16 per cent over a 12-month period. In addition, all of those occupying the top ten places recorded double-digit growth.

Top 10 ESG performers over one year as at July 26 2019

Source: Morningstar

However, not all funds fared quite so well, as the bottom four performers all fell in value over the past year, but the same could be said for any sector.

Investment strategies

In terms of the types of strategies managers can use to ensure the ethical mandate is being met, there are three main definitions: environmental, social and government; socially responsible investing; and impact investing.

However, despite often used interchangeably, there are some key differences.

Positive screening, as it sees funds focusing on what they want to invest in, rather than what they want to cut out Peter Michaelis, Liontrust

Peter Michaelis, head of the Liontrust Sustainable Investment team, adds some further clarification about the sustainable methods fund managers use.

The first is negative screening, which, as it suggests, avoids certain industries because of the negative or damaging effects of their products. Examples include weapons and tobacco.

Mr Michaelis explains: “Another approach is to invest in sustainable themes. This is known as positive screening, as it sees funds focusing on what they want to invest in, rather than what they want to cut out.

“Such funds may concentrate on a single theme such as renewable energy while others have multiple sustainability themes that can include healthcare, resource efficiency, and education.

“Many cling to the perception that ethical investment is about what you can’t do, whereas we think it’s about what you can do.”

The third method involves engaging with the companies that managers invest in. This is called ‘impact-investing’ and is about influencing the management of firms into making positive changes to their strategy or operational management.

Which strategy is most appropriate will very much boil down to where an individual investor's values lie.

Kate Elliot, senior ethical researcher, Rathbone Greenbank Investments, says the starting point for any discussion around ESG always comes back to terminology.

“How inclusive is the use of the term ESG in this instance?

“Does it include funds with a sustainability, thematic or impact bias, or just those integrating ESG analysis into the broader investment process?” she says.

Despite these further nuances, Ms Elliot adds that, generally, the aim for most ethical investors is the desire to avoid harm and promote positive change.

“Alongside the selection of ethical and sustainable investments in the first place, an active approach to the ongoing management of investments promotes positive change through more robust voting and engagement.

"Among ethical funds, approaches will vary, and positive and negative screens, engagement policies and underlying holdings will differ.

"For us, it’s important to understand what is being offered, whether it is being delivered effectively, and if it meets the needs of our clients,” she says.

Perhaps the biggest challenge for managers when researching companies, is that not all those that claim to be taking a socially responsible approach are actually meeting the requirements.

Greenwashing

This is commonly known as ‘greenwashing’ - a term that was coined in 1980 to identify those firms that claim to be producing products or services that are environmentally friendly, but on closer inspection such assertions are found to be misleading.

“With so many new products and services coming to market, it can be a challenge to see through the greenwashing and separate the providers with genuine commitment and the right expertise from those who are simply capitalising on a marketing opportunity,” Ms Elliot notes.

Problems on this front continue to persist, too.

Research from Global Investment Alliance, published earlier this year, found that assets in European sustainable funds fell from 53 per cent in 2016 to 49 per cent at the start of 2018 with greenwashing flagged as the main culprit.

This led to concerns that some funds' ethical strategies were in fact being overstated.

But some commentators suggested were more encouraged by the data, suggesting the trend supported the notion that managers are prepared to jettison funds that are not meeting the necessary sustainability requirements.

Mr Kamhi provides some examples of the greenwashing challenges investors may face when selecting managers.

The first is when a manager misrepresents their fund as sustainable.

A example of greenwashing is a thematic fund which suggests it is ‘green’, includes issuers which the objective observer would not class as sustainable

“An example would be the purchase of ESG data which is then never, or only rarely, used as part of investment decision-making,” he says.

Another, he explains, is when a thematic fund which suggests it is ‘green’, includes issuers which the objective observer would not class as sustainable.

“[A further] example could be where the engagement work carried out by an investment management firm is done by ‘corporate governance’ staff members who do not interact with the fund managers holding the issuer,” he adds.

These issues aside, for advisers, the speed of developments within the sector means that clients with specific sustainability needs should be catered for.

Mr Kenny explains: “There is a great opportunity for an adviser to add value by navigating the plethora of investment options to ensure a close fit with their clients’ requirements.

"For example, for some, excluding sin stocks such as oil and gas is all important, while for others, investing in fossil fuels is acceptable if a company is taking positive steps in developing renewable energy capabilities.

"Thankfully, there is now an investment strategy to meet nearly all client expectations.

craig.rickman@ft.com