ESG investing explained: types, demand and impact

What are the different types of ESG investments available to investors?

Deirdre Cooper (DC): So, there are a very wide range of different types of ESG investments available to investors. We have passive investments, so investments that track a typical global equity index. And we have active investments. So, those are the ones where fund managers, like my team and I at Ninety One, do fundamental research on companies, often meet managements, and then buy companies where we have high conviction in the business and in the investment case. And then across both of those areas, you also have a spectrum of ESG investing.

So, the first stage would probably be exclusionary screens. These are often described as ethical products. So, these are investment products where investments in areas that are typically seen as controversial from a sustainability perspective, are excluded. But that’s really the entry level. And then you move on to what might be described as positive tilting, or best in class. And those would be investment products that either aim to invest in companies that have been reviewed by some sort of ESG assessor and given a high score.

And then you move on towards thematic investments or positive impact. And this is a little bit different. So, this is looking not just at how the company is run, but what its products and services do. So, in areas like this, you have products like the one I co-manage, the [Ninety One] Global Environment strategy, which is looking to invest in companies that have products and services that are the solution providers for climate change. So, those would be companies that make things like wind turbines or batteries for electric cars or insulation for people’s roofs or energy efficient factories and so on and so forth. And we look to measure – and not all the funds do but many do – the impact of those products and services.

And, of course, it’s broader than just climate. People will look to invest in companies that have a positive impact on health by developing new pharmaceutical products or digital inclusion or financial inclusion. So, there’s lots of different areas where you can have a positive impact. And that’s sort of the far end of the spectrum in terms of sustainable or ESG investing.

Why is there a growing demand for ESG investments?
Kate Hewitt: So, I think people are quite familiar with the idea that you can vote with the pound in your pocket. They don’t purchase from brands that operate in a way that they disagree with. But I think for a long time the idea that you could include your financial arrangements in that decision as well, hasn’t really been at the forefront of people’s minds. And I think now there’s a greater understanding that where your pension is invested, where your ISA is invested, all of this is potentially being invested in companies that you wouldn’t purchase from, where you wouldn’t make a decision as a consumer to purchase from. So, you shouldn’t really have your finances invested with them as well. And people have been able to act with more empowerment, to make the appropriate changes so that their investment portfolios reflect their ethical beliefs.

Do these types of investments really help the environment?
DC: Well, it’s a really good question. So, the first thing I’d say is you have to be very careful when you’re thinking about impact, in separating your investment impact from the company impact. So, you will often see people talk about ‘this portfolio is 50% lower carbon than the benchmark and therefore you avoid carbon by investing in this portfolio’. That clearly isn’t true, right? Because those companies invested before you bought them and they’ll invest after you bought them. So, your portfolio is potentially lower carbon risk. It might perform better if the world prices carbon, but you aren’t necessarily avoiding those emissions. So, you certainly can’t take those emissions and go off and take a flight to New York and say, ‘Well, I’ve offset it, you know, because I moved my pension around,’ … that’s a very different thing.

But the companies that you invest in, particularly as you move towards the thematic and the impact end of the spectrum we talked about before, are really having a positive impact. And it’s very important that we acknowledge that and that when we invest in companies that, for example, are the solution providers for climate change, and we talk to the managements and we say, we really want you to make more and more of these widgets that go into electric cars and less of the widgets that go into combustion engines, because that will help drive and proliferate the adoption of electric cars, and that’ll help the world to decarbonise, then those companies are having an impact and you are increasing that impact through your engagement. So, you just need to be very careful about how you parse it. It’s still not impact that you can use to offset your steak or your flight to New York or your car, but those companies are having a positive impact. So, that’s certainly how we think about it.

Does sustainable investing lead to lower returns?
Mike Appleby (MA): That’s a great question. So, recently, over the last couple of years, many – not all – sustainable investment strategies have not performed particularly well, compared to the rest of the market. And that’s mainly because inflation has gone up and interest rates have gone up. And the kind of companies that sustainable investment strategies invest in are growth companies where a lot of the value is out in the future. And it’s just a mathematical thing: when interest rates go up, the future value of cash flows goes down.

So, that’s in the short term, but certainly over a longer time period, say a decade or so, there are many sustainable investment strategies that are doing just as well, if not better, than the other strategies that are non-sustainable. So, longer term there’s no evidence to suggest that it will necessarily underperform. In fact, to the contrary, a lot of these strategies have delivered very competitive investment returns over that longer timeframe.

Why should an investor consider ESG funds in their portfolio?

DC: I think you should have an allocation to those companies that are the solution providers for the world’s biggest problems. You know, those companies are going to see structural growth ahead of cyclical; that will bring different performance drivers. It’ll probably work particularly well in a really low growth world, might work less well in a world that’s really worried about inflation and interest rates.

And then there is the impact element. I think if you want to allocate capital to companies that are doing a great job, that are developing products and services, that are helping to solve the world’s problems, and have people running the money that are talking to those management teams all day, every day, asking them to spend more and more resources, whether that’s capital or people or R&D on those areas that have the potential to solve the world’s sustainability problems, then to some extent, you are putting your money to work in a way that can have a positive impact.

So, I think there’s two reasons to do it, and both are important.