Demystifying ESG investment strategies: A Beginner’s Roadmap

There’s a growing buzz around ESG investing in today’s investment landscape, But what exactly is ESG, and why is it gaining so much attention? 

ESG stands for Environmental, Social, and Governance – three key factors  investors are increasingly considering alongside traditional metrics when making investment decisions. 

According to Rob Sharps, president and chief executive of T. Rowe Price, these elements can impact the “sustainability and long-term success” of businesses. “Identifying, analysing, and integrating information about ESG risks and opportunities help enhance our ability to make better investment decisions and pursue better outcomes for our investors,” he said.

In this beginner’s guide, we’ll take a closer look into the world of ESG investing, exploring its principles, importance, key components, strategies, and how to get started.

Understanding ESG investing

ESG investing involves evaluating companies based on their environmental impact, social responsibility, and governance practices. This approach aims to identify companies that are not only financially sound but also demonstrate ethical and sustainable practices. By integrating ESG criteria into investment analysis, investors can gain a more comprehensive view of a company’s long-term prospects and risks.

However, it’s also worth pointing out there can be confusion as to what actually constitutes ESG, according to Rahab Paracha, sustainable multi-asset investment specialist at Rathbones. “This isn’t surprising given the lack of consistency in the language used by asset managers, regulators and the media on the topic,” she said.

That’s why it’s important that you understand exactly how a fund defines ESG and which elements it prioritises before deciding whether it meets your needs.

Read more: The most Googled ESG questions … and their answers

Why ESG investing matters 

ESG investing offers benefits for both investors and society as a whole. One benefit for investors is how it can lead to improved risk management.

Environmental risks such as climate change-related disruptions, social risks stemming from labour disputes and governance risks like corporate scandals or ineffective leadership can all impact a company’s long-term viability and financial performance. By considering ESG factors, investors can build more resilient portfolios that are better equipped to withstand unforeseen challenges.

Additionally, numerous studies have demonstrated a positive correlation between strong ESG performance and financial returns over the long term. Companies prioritising sustainability, diversity, and ethical governance often exhibit better operational efficiency, reduced regulatory and legal risks, and enhanced brand reputation, all of which can contribute to sustained financial outperformance.

Furthermore, ESG investments allow investors to align their investments with their values, promoting sustainable investing and positive societal and environmental impacts.

By directing capital towards companies that promote sustainable innovation, resource efficiency, and social inclusion, investors can contribute to positive societal and environmental outcomes. Moreover, shareholder engagement and advocacy efforts can incentivise companies to adopt more responsible practices, driving positive change at both the corporate and systemic levels.

Key components of ESG strategies

• Environmental factors: Environmental criteria include factors such as carbon emissions, energy efficiency, and renewable energy usage. As climate change continues to pose risks to businesses worldwide, investors are increasingly assessing companies’ efforts to mitigate environmental impact and adapt to a changing climate.
   
• Social factors: Social considerations encompass issues such as diversity, labour practices, and human rights. Companies that prioritise corporate social responsibility and community engagement are viewed favourably by ESG investors, as they demonstrate a commitment to ethical business practices and stakeholder well-being.
   
• Governance factors: Governance criteria focus on aspects such as board diversity, executive compensation, and transparency. Effective corporate governance is essential for fostering accountability and integrity within organisations, which is integral to driving sustainable business practices and long-term value creation.

ESG investment approaches and strategies

1. Negative Screening

Negative screening is an ESG investment strategy involving excluding companies or industries that do not meet certain ESG criteria from investment portfolios. Common exclusions may include companies involved in fossil fuels, tobacco, or controversial weapons

2. Positive Screening

Positive screening identifies companies with strong ESG performance and positive societal impacts. Investors seek out companies that demonstrate leadership in sustainability practices and contribute positively to their communities.

3. Integration

Integration involves incorporating ESG factors into traditional financial analysis. This approach allows investors to assess both financial performance and ESG considerations when evaluating investment opportunities, leading to more informed decision-making.

4. Impact Investing 

Impact investing aims to generate measurable social or environmental impact alongside financial returns. Investors actively seek out opportunities to support companies or projects addressing pressing global challenges, such as climate change or social inequality.

5. Thematic Investing

Thematic investing is an approach that involves building investment portfolios around specific long-term trends or themes that are expected to shape the future. Instead of focusing on individual companies or sectors, thematic funds aim to invest specifically in sustainability-related themes, such as low carbon, clean energy or water.

6. Shareholder Engagement 

Shareholder engagement involves actively engaging with companies to advocate for ESG improvements. Through dialogue with company management and participation in proxy voting, investors can influence corporate behaviour and encourage greater transparency and accountability. 

How FundCalibre considers ESG in our fund research 

Every Elite Rated portfolio will have been analysed on the basis of its approach to ESG. We highlight what aspects are particularly important to the fund manager and how the team helps ensure holdings meet their requirements.

To keep things simple, we assess each fund as either ESG Explicit, ESG Integrated or ESG Limited. Here’s a quick overview of what those assessments can tell you. 

• ESG Explicit: These funds have an ESG/sustainable approach at the forefront of their investment philosophy. The managers will go above and beyond simple integration, with an ESG filter used as a primary feature of the investable universe, and with ESG considerations having a fundamental impact on the stock selection process. All three environmental, social and governance factors will need to be considered when building the portfolio and there must be ongoing engagement with investee company management. 

• ESG Integrated: These funds embed ESG analysis within the investment process, as a complementary input to decision making; however, the investment universe will not necessarily be restricted in any way. At least two environmental, social and governance inputs will need to be considered before permitting a stock into the portfolio. Managers who hold stocks with questionable ESG credentials will need to provide strong rationale for including the stock in the portfolio and show that extra analysis has been undertaken to accommodate the ESG risk. 

• ESG Limited: Funds in this category are those whose overall portfolio will not be materially influenced by ESG. It’s important to note that these funds may still have some element of ESG in their process or be managed by a company that enforces certain negative screens, but the overall portfolio will not be influenced by ESG.

How to Start ESG Investing

1. Assess personal values and goals: Reflect on your values and what issues matter most to you. Consider how you can align your investments with causes you care about. Passionate about animal welfare? For example, you may look for funds that have a negative screen on animal testing.

2. Research ESG funds and investment options: Explore ESG funds and investment products aligning with your values and investment objectives. Look for funds with strong ESG ratings  via external organisations or use FundCalibre’s ESG research highlighted above to help narrow down your selection.

3. Evaluate ESG metrics and reports: Familiarise yourself with ESG metrics and reports used to assess companies’ environmental, social, and governance practices. Companies increasingly publish sustainability reports that demonstrate to shareholders – and potential investors – their approach to ESG. This enables them to be very open and transparent about the risks and opportunities they face and how they tackle them. Understand how these factors contribute to a company’s overall ESG profile.

4. Consult a professional: If you’re still unsure about the jargon and terminology, you can always seek guidance from financial advisors or investment professionals  in ESG investing. They can provide personalised recommendations based on your individual circumstances and goals.

Conclusion

ESG investing offers a compelling opportunity for investors to align their financial objectives with their values and contribute to positive societal and environmental outcomes. By considering environmental, social, and governance factors alongside traditional financial metrics, investors can build portfolios that not only seek to deliver attractive returns but also make a meaningful difference in the world. 

As you embark on your ESG investment journey, remember to stay informed, stay engaged, and continue exploring opportunities to invest in a better future. 

Ready to start your ESG investment journey? Start researching ESG funds and investment opportunities today. Let’s build a better world together.