Why it pays to think carefully about ESG investing

Woke. It’s the modern-day equivalent of being called a ‘do-gooder’ or ‘politically correct’. It can be a pretty stinging insult.

It’s a phrase that’s been levelled more than a few times at ESG and the concept of sustainable investing. Even though being a responsible investor is becoming much more mainstream, some critics still see it as a distraction from the real business of making money.

Larry Fink, CEO of BlackRock, the world’s biggest investment firm, disagrees. 

In this year’s annual letter to CEOs, he was at pains to point this out: “Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘woke’,” he said. “It is capitalism.”

To Fink, the future belongs to sustainability. He predicts that the next 1,000 unicorns (private firms worth more than US$1 billion) will be “sustainable, scalable innovators that make the energy transition affordable”. 

ESG is not just about the environment

There’s still sometimes a misconception that ESG is a passing fad – an investment style that will eventually go out of fashion. One of the problems that supporters of responsible investing face in winning over the sceptics, is that we can tend to get stuck on thinking about the first part – the environment.

It’s hardly surprising. Climate change is a global problem that demands urgent attention from governments and companies alike. But it’s not the only issue. 

We shouldn’t forget that the other aspects of ESG – social and governance – are also very important when it comes to weighing up a company’s credentials and thinking about whether you should invest.

One of the most notable ESG scandals of recent years was a social issue. Fast-fashion company Boohoo saw its shares tumble after a newspaper investigation into one of its suppliers uncovered claims of low wages and poor standards for factory workers.

In fact, what many investors will tell you, is that ESG analysis starts with the last of the three – good governance. 

We’ve seen a big push from investors to make big firms like Facebook clean up their corporate governance, so they can rebuild trust with their customers – and their shareholders. But actually, scratch the surface of most recent corporate scandals – and very often it all comes down to the governance.

If it’s an energy company dealing with an oil spill, that’s a potential environmental disaster and a PR crisis that will probably lead to the share price nosediving. But that spill is probably just a symptom. The cause is likely to stem from the firm responsible cutting corners on safety and regulations. Get the governance right, and the rest, in theory, will follow.

What makes a good ESG investment – it can be difficult to judge

You could say that investors interested in ESG are now spoiled for choice. More companies are taking sustainability seriously – and for investors there are more sustainability-focused products and mechanisms we can use to make better judgements on a firm’s credentials, such as ESG ratings.

But this all comes with a major health warning. Sustainability is a potential minefield. Attempts to score companies on their relative ESG strengths can be helpful, but are also sometimes misleading. 

Take the case of Boohoo mentioned earlier. Despite the outcry, when the first story broke the stock was actually held in many ESG funds. 

Possibly an even more surprising example is a company like Imperial Brands. As one of the so-called ‘sin stocks’ tobacco is a pretty controversial choice of sector for some investors. But MSCI, the largest ESG rating company, has scored it an A.

This shows that a company can score highly in many areas, it can be a good employer, have a diverse board, and have policies to cut its carbon footprint, but is it a company that someone like my client Jayne would think of as the sort of sustainable investments she wants to invest in? In other words, you can put out a terrible product or service and still tick the right boxes.

Not the time to do-it-yourself 

So what should we take from this? We can see that ESG investing isn’t just a case of blind idealism. It isn’t woke, it’s a sensible practice to help avoid risk (and also open you up to other potential investment avenues).

There are increasing strategies that brand themselves as ‘sustainable’ or ‘ethical’. But professionals and amateur investors alike have to beware of not to be swayed by the marketing speak. 

You need to know you’re investing in companies that aren’t going to face lawsuits further down the line, or aren’t another environmental, social or governance scandal waiting to be uncovered. You want companies that are genuinely offering long-term sustainability, not just ticking a box or wearing an ESG badge.

But unless you’ve got the time and the technology, ESG investing isn’t something for the DIY investor. That’s why it’s essential to take advice and work with advisers and fund managers who know what to look for.