Sustainable investing

ESG stands for environmental, social and governance. Broadly speaking, these headings provide the framework which allow investors to assess a company’s or fund’s sustainability credentials. They often overlap, and it can sometimes be hard to tell where an issue belongs as many environmental issues have social implications – and vice versa.

You might also find that ESG is often referred to as ‘sustainable investing’.

For many investors ethical issue are also important, such as avoiding armaments companies, tobacco manufacturers or companies with poor animal welfare standards. Many ESG and sustainability funds consider these issues although the funds we label as ‘ethical’ typically have the highest requirements.

People often swap out terms like ‘sustainable’, ‘ethical’, ‘SRI (socially responsible / sustainable and responsible investing)’ and ‘ESG’ (environmental, social and governance) for each other. But while there is overlap, these terms were coined originally to lead to slightly different investment decisions.

ESG originated from investors wanting to reduce investment risk by researching how companies manage the environmental, social and governance issues that are relevant to their businesses. Sustainable investment was originally concerned with helping to shape a greener, more sustainable future.  And ethical investment is an older term which strived to bring personal values into investment decision-making.

Fidelity’s ESG spectrum incorporates both ethical and sustainable investing.

Before we had several decades of performance to look back on, there was a view that ESG and sustainable investing could lead to underperformance as fund managers’ options were more restricted.

It has become increasingly clear that companies that have higher environmental, social and governance standards are often better managed businesses and therefore more likely to succeed. In addition, funds which invest in companies that are ahead of regulatory change and helping to make progress possible are increasingly able to disrupt older business models. However, like any investment, the value of ESG and sustainable investments can go down as well as up, so you may get back less than you invest.

‘Greenwash’ is where fund managers (or others) mislead potential clients by making false or exaggerated claims about a company’s or fund’s environmental standards.

The best way to guard against most aspects of greenwash is to look closely at what a fund is designed to do. Funds that say they exclude a particular area, such as tobacco or oil companies, can be expected to do exactly that.  Funds that say they will invest in line with named themes, such as renewable energy or healthcare, are more complex to monitor but can be expected to hold companies that align to those themes. Funds that say nothing on these topics, or are unclear in their communications, cannot be expected to invest in any particular way and their views about particular issues may different from your own.

Funds also have different positions on stewardship – or engaging with companies to encourage them to adopt higher standards – which can lead to different investment decisions. Funds that rely substantially on stewardship activity may hold more controversial companies with the aim of encouraging them to change. So, if you are keen to avoid potentially controversial companies you may prefer to consider funds with stricter exclusions or a stronger focus on positive themes - such as sustainability themed or ethical funds.

It’s also important to remember that many listed companies are very large and complex.  Most have both positive and negative features - so where one fund manager may see problems another may see a useful service or valued employment opportunities.

Ultimately, guarding against unwelcome surprises comes down to carrying out your own due diligence as strategies vary. You should start by looking online and even visit the fund manager’s own website, to understand what an individual fund sets out to do, its purpose and where it will and won’t invest.

Find out more about greenwashing and how to protect against it.