ESG funds are on track to outnumber conventional funds by 2025 and are forecast to increase their share of the European fund market to 41%, with assets rising by 3.8 trillion. Sound like a bandwagon you might like to jump onto but don’t really know the ins and outs? Let’s break it down.
ESG stands for Environmental, Social, and Governance.
There are many different definitions of ESG fund, but simply put, they’re funds that invest based on the environment, social, governance principles of a company. It’s all about backing companies that care, and making investments with a clear conscience. You can watch your portfolio grow in leaps and bounds, and sleep easily at night knowing your investment is aligned with your beliefs.
ESG-focused investments have been the darling of Wall Street in 2020, with investors pouring record amounts into sustainable investment funds during the COVID-19 pandemic. It’s typical for people to reduce spending on luxury goods when times are tough, and this increase in ESG shows that the perception around investing in sustainability is not just something that gives you a warm, fluffy feeling – it’s a necessity and the way of the future.
Historically, investment recommendations were based on a company’s financial reports, with revenue, operating margins, and debt levels checked over with a fine-toothed comb. Companies were valued purely on their bottom line, and questionable behavior and negative impacts were conveniently ignored. The introduction of ESG scoring around 2000 didn’t exactly take the world by storm – it’s been a slow burn that’s blossomed into a passionate affair. To make it crystal clear, let’s look at the numbers. Between April and June of this year, ESG funds attracted net inflows of $71.1bn globally. The amount of new money invested is more than the combined flows for the past five years. It’s that hot.
ESG-focused funds base their investments on companies that care more about just turning a profit. These are companies that focus on the greater good. They’re committed to having a positive impact both in the communities they operate in and on a global scale. Giving an Environmental, Social, and Governance (ESG) a detailed score, then combined to create a total score provide investors with the clarity they demand.
Previously, investors would sleep with a clear conscience by including exclusions in their investment strategies. Not investing in countries perpetuating humanitarian crises was one way. Avoiding companies manufacturing guns and tobacco, or the gambling and oil sectors is where many investors draw the line. The process was cut-and-dried, but not exactly insightful. That’s where ESG differs. Its analysis is granular, taking into account criteria such as:
• How does the company’s business affect the environment?
• What does the company do to prevent human rights violations?
• Does the business model or support equal rights in the workplace?
• Does the company proactively combat corporate corruption?
• How are risks of corruption reduced?
The factors can be combined. For example, an ESG portfolio might hold companies with low environment scores but high governance scores, and it’s easy for an investor to drill down into these numbers for a clear understanding of what they’re supporting, as well as understanding any risks involved. Informed decisions can then be made based on what matters more to them on a personal level, and what resonates with their values.
And getting back to the dollar figures, research indicates that companies with solid ESG-related practices produce higher excessive returns. With the success of these funds in 2020, it seems the sky is the limit.