Environmental Investing

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

When I talked about ESG investing a few weeks ago, I explained that it’s not quite as simple as just investing ‘ethically’. ESG comprises three distinct tenets - Environmental, Social, and Governance - and lumping them under the same broad banner of ‘ethical’ investing risks diminishing the unique qualities of each. With that in mind, I’ll be looking at each in turn to understand how E, S and G can all play a part in your portfolio.

What’s E on about?

Images of wind turbines and luscious forests are probably what first spring to mind when you think about ESG investing - the ‘E’ side rightly attracts huge focus right now, as companies and investors look for ways to tackle the environmental crisis.

It’s also perhaps the most complex area of the three. Environmental investing covers a wide range of different areas, from climate change to waste reduction to deforestation. Each presents its own assortment of competing ‘solutions’, investment strategies and, of course, funds to choose from.

It’s worth noting that, for the time being at least, there’s no clear answer to these problems, and this article is hardly trying to provide one. There are, however, an increasing number of ways to ensure that your investments reflect whatever matters most to you.

And even if you’re not that bothered about the environment, we shouldn’t downplay the financial sense it makes to factor it into your investments.

It’s important that we look at our investments with a long-term perspective and consider what trends are likely to affect our portfolios over the long run. The environment is one of those themes that is certain to influence how economies and companies perform in the coming years, and those that want to thrive need to take the problem seriously. Though not solely focussed on environmental investing, a Bank of America study estimates that over the next 20 years there could be $15-20 trillion of asset growth in ESG funds — just shy of the current size of the S&P 500.

And we’re already seeing how businesses that fail to adapt are starting to get left behind - earlier this week, BP confessed that the demand for oil may now have peaked, and could henceforth only decline as we seek alternative, greener sources of energy.

Nevertheless, environmental investing remains a relatively unknown area for most investors. Here’s how you can start incorporating it into your portfolio:

1 - Negative screening

When we talk about any kind of ESG investing, there are usually two ways a fund might assess a company’s credentials. The first is via a negative screening process, where managers exclude firms that don’t meet their required ESG standards.

How investment teams go about that screening process will vary, but it’s a strategy that many sustainable funds now adopt, meaning that traditionally environmentally damaging industries like oil and mining are now excluded entirely from lots of ESG funds.

Bryn Jones, manager of the Rathbone Ethical Bond Fund, applies a negative screen at the end of his investment process, to ensure that the companies he likes do not run against his fund’s ethical standards, without narrowing his investment universe from the offset. Similarly, Terry Smith’s popular Fundsmith Equity Fund now offers a ‘sustainable’ version, which excludes its parent fund’s holdings that come from sectors like mining, fossil fuels and tobacco.

Investing in funds that negatively screen against environmentally damaging companies is a good way to ensure your investments don’t inadvertently run against your morals - plus it reduces your exposure to those businesses that are likely to struggle in a greener world.

2 - Positive screening

Some funds adopt a positive screening process, where they don’t simply filter out companies with poor ESG credentials, but rather seek out ones that actively do good (and many funds, like the above Rathbone fund, do both). Since there is no consensus on what constitutes ‘doing good’, this is a hugely diverse area.

Clearly, the decision of how best to invest your money with an environmental focus is ultimately up to you. If there is one area which particularly matters to you, there’s likely to be a fund suited to those objectives, just as there are funds which offer a range of solutions across diversified sectors. The best way to match your investments with your morals is to do your research, understand your fund’s philosophy, and make sure their holdings are all companies you like.

The Fidelity Sustainable Reduced Carbon Fund is one of a handful of bond funds which look to build a greener future while delivering meaningful returns to investors. While its holdings all have to meet strict carbon reduction criteria, the fund’s managers, Kris Atkinson and Sajiv Vaid, believe the best way to deliver change is not through exclusion (though it does screen against certain industries like tobacco and controversial weapons) but through engaging with companies and encouraging them towards greener solutions.

One option with a different focus is the Fidelity Water and Waste Fund. While the above fund looks to encourage change through investing in low-carbon holdings across sectors, this one focusses specifically on issues surrounding (as the name suggests) water and waste. The fund’s manager, Bertrand Lecourt, believes that with an ever-expanding population, demand for water intensive goods and services is growing - and so is the level of waste they leave behind. The fund aims to invest in companies offering innovative solutions to such issues.

3 - Apply your own screening process

Ultimately, there are plenty of funds out there to choose from. And while trying to make sense of the entire fund universe can be difficult, there are certain ways you can incorporate ESG strategies into your own portfolio. Look at your funds’ Top 10 holdings - do those companies reflect what matters most to you? And do you think they’re going to have any place in a greener future? If not, maybe they’re not the best choices for a long-term investment.

More on ESG investing

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered

ESG investing, Funds