How does ethical investing affect your portfolio?

How does ethical investing affect your portfolio?

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in our Edgbaston or Warwick offices.

Does it pay to invest in green and other “ethical” investments? For many years, ESG investing (pro environment, society and corporate governance) sat outside the mainstream due to fears that pursuing ethical goals was incompatible with maximum returns. As an example, a company might have a better chance of making a profit if workers’ wages are kept as low as possible (e.g. using “cheap labour” in east Asia rather than more costly workers in Europe).

However, studies have repeatedly shown a positive correlation between ESG and corporate performance – giving investors strong returns. In this guide, our financial planners at Wealth Solutions explain how ESG investing works, its relationship with investment performance and the main ways it can be incorporated into a portfolio. We hope this is helpful to you. If you’d like to speak to an independent financial adviser then you can reach us via:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

What is ESG investing?

Traditionally, investors’ main priority was to find businesses with the best prospects to produce a strong return. The behaviour, activities and values of these businesses was less of a concern as it is today. In 2022, however, investors are increasingly calling for companies to make a positive impact on the wider world – not just produce a dividend and/or capital gain. ESG is a term used to encompass three main areas of ethical concern, in this respect:

  • Environmental. Does the company harm the natural environment? What kind of carbon footprint does it have across its supply chain?
  • Society. What kind of impact does the business have in the wider society it operates in? For instance, footwear companies operating factories in developing countries might seek to make a positive impact by offering employees fair pay and working conditions. Perhaps its suppliers are prioritised/demoted partly on ethical grounds such as their own treatment of staff, hiring practices or track record on advocacy for social good.
  • Society.
  • Governance. This mainly refers to the composition and behaviour of the company board. For example, is the board overwhelmingly made up of white men, or have efforts been made to increase diversity? Are directors responsive to the concerns of shareholders or do they ignore them? Are efforts being made to increase corporate transparency?

It’s important to note that other terminology is sometimes used as a synonym for ESG investing – or to refer to a specific aspect of it. For instance, ESG is sometimes used interchangeably with “socially responsible investing” (SRI) whilst “environmental investing” concentrates primarily on investing in companies which seek to protect the natural world (or, at least limit damage to it).

Does ESG affect investment returns?

Despite historical misgivings about ESG acting as a downward pressure on performance, new studies show a strong link between investment returns and high company ESH scores. Indeed, companies which seek to “do good” to “people and planet” are often those which are managed well and plan to address long term risks.

One study in the Journal of Sustainable Finance & Investment looked at 157 stocks that are members of the Dow Jones Sustainability Index (DJSI) – comparing them to 809 which are not. Across all industries, the DJSI members showed 28.67% less stock market volatility compared to the non-members. Research by Salama, Anderson and Toms (2011) confirmed a similar picture amongst UK companies, showing there was an inverse relationship between environmental performance and financial risk.

In short, ESG investments arguably perform better than non-ESG companies in the long term and also plausibly pose a lower volatility risk.

How to incorporate ESG into a portfolio

There are many ways for an investor to approach ESG. Perhaps you want to start including ESG slowly into your portfolio. Others may wish to be “radical” and only invest in companies with a strong ESG record. Broadly speaking, there are four ways to invest in ESG:

  • Exclusion. This approach involves “screening out” all companies and industries which are deemed unethical (e.g. fossil fuels and gambling).
  • ESG integration. Here, an investor might integrate high-scoring ESG investments into his/her portfolio slowly, where a favourable risk-reward profile can be demonstrated.
  • Inclusionary investing. Some companies may operate in a “low scoring” ESG industry (e.g. fossil fuels), but are demonstrating leadership amongst rivals in transforming their business model and moving towards “carbon neutrality”. Those deemed to offer a good risk-return profile might be considered for the portfolio.
  • Impact investing. This type of ESG investing tends to concentrate on companies which can provide a measurable impact on the environment – e.g. those involved in renewable energy.

Which type of ESG investing might be right for you? It depends on your values, goals, personal risk appetite and investment horizon. At Wealth Solutions, we can help you work through the different options so that you can make informed decisions about your portfolio.

Invitation

We hope this content has been informative and inspired you to develop your own financial plan. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:

T: 0121 446 5815
E: [email protected]

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