The promise of ESG (Environmental, Social and Governance) investing has been evasive for many investors. Confusion around what “ESG Investing” is has led many investors to become disillusioned with their portfolios. So, what is “ESG investing”? Is this the same as ethical, responsible or green Investing? The straightforward answer is ‘no”. Unfortunately, many in the industry, academics, and investors use these terms interchangeably. They are, depending on your perspective, very different things.
Why Investors Are Confused About ESG Investing
For retail investors, these terms tend to coalesce around the concept of a “good” portfolio that doesn’t own companies that “do bad things”. The definition of “bad things” differs from investor to investor. Does this include just landmines and tobacco? Or does it extend to broader “sin stocks” like gambling, pornography and alcohol? Is coal mining terrible? Or is all mining bad? Is coal-powered electricity generation on the “bad’ list? What about uranium? Does an exclusion on tobacco include the company making cigarette packaging or the supermarket selling them in their stores?
All these considerations usually fall within the gambit of a portfolio’s list of exclusions. i.e. what is prohibited from the portfolio? There are more complex considerations like materiality levels and supply chains, but the core of the investor expectation is generally what they don’t want to see in their portfolio investment portfolios. Given issues with data quality and transparency from companies, specificity around materiality levels and details around supply chains up and down the value chain, and the active part being played by regulators guarding against perceived greenwashing, many investment managers are increasingly finding making “hard exclusions” a risky business proposition.
Ethical Investing: Aligning Your Portfolio with Personal Values
While some products, usually (but not always) described as ethical, contain these exclusions, this is not what most institutional investors consider “ESG integration”. Following the establishment and global adoption of the United Nations Principles for Responsible Investment (UNPRI), the definition of responsible investing and ESG investment has taken a significant turn. The UNPRI effectively defines the integration of ESG factors into investment decisions as the key defining action of Responsible Investment. Principal One states, “We will incorporate ESG issues into investment analysis and decision-making processes”. This doesn’t say anything about how to incorporate these issues, nor does it require that investors take any specific action with respect to them. Given this, investment managers are open to “incorporating ESG” in any manner that suits their investment process.
Subsequently, both advisers and investors must recognise these differences. Failure to do so can muddy the discourse around sustainable finance and lead to ineffective investment strategies.
What ESG Investing Really Means
Ethical investing is a values-driven approach in which investors choose companies based on their personal moral compass. This may include avoiding industries like tobacco, alcohol, or weapons, regardless of the company’s financial performance or environmental footprint. Ethical investing is highly subjective; what is moral to one person may not be to another. Ethical investors tend to focus on alignment with their beliefs rather than a specific framework.
In contrast, ESG investing takes a more systematic approach, integrating Environmental, Social, and Governance factors into investment decisions in various ways. Investors can incorporate ESG factors to different degrees, from simply screening out companies with poor ESG performance to actively selecting those excelling in sustainability or governance. Some investors may focus on specific issues, such as gender equality or reducing carbon emissions, while others look for companies that balance strong ESG practices with solid financial returns. The most prevalent approach is when investors consider ESG risks alongside all risks and ensure that the expected return from the stock or bond adequately compensates for this risk. Some strategies prioritise shareholder engagement, using the power of ownership to push companies toward better ESG performance. Whether through exclusionary screens, positive selection, or active engagement, ESG investing offers a flexible framework that allows investors to address a broad range of concerns while aiming for long-term positive financial performance. ESG investing aims to balance financial return with mitigating sustainability and corporate governance risks, often serving as a benchmark for responsible capitalism.
Green Investing: Prioritising the Environment
Green investing is laser-focused on environmental impact. Investors in this space prioritise companies leaders in renewable energy, sustainable agriculture, or carbon reduction. While green investing is a subset of ESG, it doesn’t account for the broader social or governance aspects. For example, a company may lead in reducing emissions but miserably fail regarding labour practices or board diversity.
When these approaches are confused, they dilute the progress each seeks to make, and it is vital that financial advisers and their clients understand these distinctions. Ethical investing involves aligning investments with personal values, ESG involves evaluating comprehensive risk, and green investing is purely environmentally focused.
How to Choose the Right Responsible Investment Approach
Clarifying these definitions empowers investors to make better choices, driving real change in their areas of interest. Understanding the distinctions between ESG, ethical, and green investing is crucial for making informed financial decisions that align with your values and long-term goals. While ESG integration is a powerful tool for managing investment risks, ethical and green investing take a more targeted approach based on personal beliefs or environmental impact.
At Everalls Wealth Management, we take a holistic, strategic approach to wealth creation and protection, ensuring your investments reflect both your financial aspirations and your principles. If you want to explore how responsible investing can fit into your portfolio, visit our ESG-aware investment strategies page or contact our team today for expert guidance tailored to your unique vision for the future.
Source: Lonsec
