ESG InvestingJul 13 2020

The main principles of ESG investing

  • Describe some of the basics around ESG investing
  • Explain what 'greenwashing' is
  • Describe what MiFID II means for advisers around ESG
  • Describe some of the basics around ESG investing
  • Explain what 'greenwashing' is
  • Describe what MiFID II means for advisers around ESG
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Approx.30min
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The main principles of ESG investing

Impact investing is when investment is made with the intention of generating a positive and measurable social or environmental impact.

Examples include: a social bond fund which invests in bonds whose funding is ring-fenced for projects or initiatives that have the intention of generating positive and measurable social or environmental impacts; investing in private equity where it can be demonstrated that the money invested will go towards having a positive social or environmental impact; and SDG impact funds where impact is measured against the UN SDGs.

It can be easy for a fund manager to justify that their investment has a sustainability focus but the key words here are being able to demonstrate that the impact is ‘positive’ and ‘measurable.’

Taking the example of a fossil fuel company that invests heavily into researching forms of renewable energy, it may be argued that the company targets the theme of climate change mitigation; however, it is unlikely that the company’s overall impact towards this goal will currently be a positive one.

It should be noted that a fund may not necessarily fall into just one of the above levels of ESG investing. In fact, it is likely that there will be elements of at least the first two in the fund.

Unlike the original ethical investing described above, much research has shown evidence of a positive performance effect with ESG investing, or at least no performance penalty.

Several studies have shown that a majority of ESG funds outperform their non-ESG equivalents.

Most recently, research by Morningstar analysed the impact of the market downturn in Q1 2020 caused by COVID-19 and found that 51 out of 57 (89 per cent) of their sustainable indices outperformed their broad market counterparts.  

The reason for this can be attributed to the fact that companies that score higher in terms of ESG tend to have better corporate governance policies, care more about the treatment of their employees, produce more sustainable products and are less prone to events such as environmental disasters, with their subsequent clean-up costs and expensive PR damage.

During times of market distress there is a flight to quality, which benefits these higher ESG-rated firms.

As well as numbers showing better performance by ESG funds compared to their non-ESG equivalents, another reason for the growing interest in ESG investing is the fact that new MiFID II rules will next year require advisers to ask clients about their ESG preferences and take these into account when assessing the range of financial products to be recommended to them - fund and portfolio recommendations will need to match each client’s individual ESG preferences

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