How to invest sustainably

The sustainable investment market can feel like a word salad, with terminology like climate change, energy transition, ESG, circular economy and more. While definitions are improving, it can be difficult for investors wishing to invest sustainably to make sense of their options.

Greater standardisation is coming, which should help people invest in ESG

The UN Sustainable Development Goals are a valuable tool for measuring targets and impact for investors. The EU Taxonomy looks set to bring greater uniformity to sustainability definitions for investors. In the UK, the Taskforce for Climate-related Disclosures has helped improve company and fund manager disclosure.

In the main, however, sustainable investing tends to mean what a fund management group makes it mean. This has led to accusations of ‘green-washing’, where investment groups make all the right noises on sustainability, but don’t demonstrate good practice. Investors need to do their homework when investing sustainably.

Some broad sustainability and ESG trends are clear

Some funds define themselves as ‘ESG’, meaning the fund manager takes environmental, social and governance criteria into account when making investment decisions. But this doesn’t necessarily mean excluding companies in areas that some may consider harmful, such as fossil fuels or tobacco. In many cases, fund managers will simply try to pick the best option in a particular sector or engage with companies to improve their behaviour.

Some companies – Abrdn or Schroders, for example – have an ESG screen across all their funds, even those without an ESG label. For others, these criteria will only apply to labelled funds. However, the broad application of ESG screens is the direction of travel for many firms and is increasingly likely to become the norm for fund groups.

There are also thematic and impact funds, which target a specific area that delivers a measurable impact. For example, a clean energy fund will only invest in those companies where a significant share of their revenue is derived from the transition to renewables. This has been a key area of growth in recent years.

These funds offer a range of different investment profiles – at one end are the energy infrastructure funds (Ecofin US Renewables Infrastructure, Aquila European Renewables Income Fund, Greencoat UK Wind for example), which deliver a higher income and are more defensive; at the other are funds such as Baillie Gifford Positive Change or Montanaro Better World, which target long-term growth with a clear impact.

Although measurement and reporting on impact is still in its infancy, these funds will generally be able to show how much carbon or water they’ve saved, or the social impact of their investments (such as board diversity). With broader ESG or sustainability funds, there is often no measurement of their impact.

Ratings are developing but are not clear cut

To help investors navigate the range of options, rating groups such as Morningstar or Square Mile have sustainability ratings for funds. Morningstar’s ratings, for example, assign a score for ESG metrics, and then a percentage score relative to a fund’s peer group.

While the ratings may help to inform those looking to invest in ‘green’ companies, there is some debate over how they are calculated. Electric car manufacturers are a good example, with some rating agencies scoring them highly because of the benefits of their product and others marking them down because of the carbon intensity of the supply chain. Some will give tobacco companies a high score because they are generally well-governed and treat their employees well. It is an art rather than a science.

There are several strong sustainable investing themes

Investing in water: the statistics on water usage are alarming. In Fineco’s Why invest sustainably webinar Fineco Asset Management Portfolio Manager Keith Williamson highlights that a litre of orange juice requires 1,020 litres of water and a pint of beer takes 75 litres. The apparel industry is water intensive with cotton a particular culprit - a single shirt uses 2,500 litres of water. Water scarcity is worsening across the globe. By 2025, according to World Health Organisation estimates, half of the world’s population will be living in water-stressed areas.

There are funds to improve water quality or efficiency, such as the Pictet-Water fund or the Fidelity Waste and Water fund. Alternatively, investors can look at specific stocks. Xylem, for example, improves measuring and metering, while Gerberit provides water sanitation products.

Investing in sustainable energy: this high-profile theme has considerable support from government spending packages and companies needing to address their carbon footprint. Approaches include wind and solar farm investment, battery storage and specific climate change funds.

The past few years have seen a rapid acceleration in the green bond market, which was around $1.4trn in size in October 2021. Green bonds are issued by governments and companies, with proceeds ear-marked specifically for green projects, such as the adoption of renewable energy, or better water efficiency. Many of the EU’s Green Deal initiatives are likely to be financed by green bonds. In September 2021 the UK Government’s first green gilt issue raised £10bn to finance green projects.

Those investing in ESG can now build a diversified portfolio entirely from sustainable options, for example using broad-based sustainability funds, thematic funds or single stocks targeting specific areas. The Fineco platform has a broad range of investment options and asset classes from around the world, with fair and transparent pricing.