Ethical investing guide: how to research ESG investments

Investment groups have got wise to the power of the ‘ESG’ label, and the fund flows it can bring. However, until recently, there had been little consensus on what that means in practice. This made it difficult for investors who wanted to make sure their investments match their values. Now, labelling is improving and investors can increasingly make more informed decisions on their ESG options.

While the impetus behind the sustainable investing movement is to be applauded, it has come with some teething problems. Without clear definitions on the parameters and language of responsible investing, fund managers and investors have had to feel their way. 

Looming in the background are persistent concerns over ‘greenwashing’ - companies and investment managers inflating their environmental credentials to appeal to green investors. There is also considerable debate on what ‘good’ looks like – is Tesla a hero for pioneering electric cars, or a villain for the carbon emissions in its supply chain? This has made ESG analysis difficult for investors.

Was an investment ethical? Exclusionary? Did it integrate ESG? There were multiple different approaches and investors couldn’t always be sure what they were getting. However, some general consensus has now emerged on the basic levels of sustainable investing.

Fund research group Defaqto says investors can view sustainable investing as four levels of a pyramid. At the bottom, is ESG integration.

The EU has led the way with its category 8 and 9 funds. Category 8 funds are ESG-focused funds, while category 9 funds are closer to impact investment funds. In the UK, the FCA has proposed a range of fund labels - “sustainable focus”, “sustainable improvers” and “sustainable impact” as part of the incoming Sustainable Disclosure Requirements (SDR).

The EU has also brought in an environmental taxonomy, which is designed to bring some standardisation to the terms used within sustainable investment. There is also a draft social taxonomy, which is going through the approval process. Other regulators around the world are bringing in similar initiatives. This is helping to build a framework for companies to measure and report on ESG issues, and for fund managers to hold them to account.

The UN’s Sustainable Development Goals have also been important in building a common purpose and language around sustainable investment. These include social targets, such as high quality education, good health and wellbeing and reduced inequalities, but also environmental goals, such as responsible consumption and production or climate action.

For example, MSCI has ESG ratings for each company, labelling them laggard, average or leader. It also has ESG indices, which weight different companies according to certain ESG criteria. Morningstar has its Sustainalytics, which assigns each company an ESG risk rating. These can save investors considerable research time. Those who want to do it themselves will need to look at individual research groups to pick up data on key factors such as plastic pollution, or carbon emissions.

Morningstar also has fund level sustainability ratings, which can help investors pick suitable funds. And there is an increasing number of multi-asset sustainable options which provide a one-stop shop for ESG investment. Groups such as Fidelity, M&G, Baillie Gifford and JP Morgan Asset Management have all built sustainable multi-asset options. There are an increasing number of bond and property funds that now have sustainable characteristics too, so it is becoming easier to build a fully diversified responsible portfolio. 

It can be worth looking at the strength of a fund group’s ESG resources and the type of engagement they have with companies. This should all be freely available on their websites. It will give a clear indication as to whether a fund group’s ESG credentials are as strong as they say they are.

When researching the best ethical investments, it is important not to ignore the usual characteristics of a good fund. Like any other investment, ESG options must be appropriate to the investor’s goals, personal circumstances and attitude to risk. Investors also need to be assured that the fund manager is a capable stockpicker and can generate strong returns.

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