Adam Keen, head of Paraplanning at Arlo International looks at how investors can be helped to start ESG investing in a way that truly meets their needs.
Environmental, social and Governance (ESG) issues have been a part of people’s lives for some time now, withextreme weather events across the globe and Greta Thunberg-inspired climate protests making headlines in recent years. Inevitably, such events have had an impact on how people want to spend and invest their money, as more consumers than ever want to save and invest in companies that have a positive impact while avoiding those that do not meet their environmental, social, or ethical standards.
The subsequent growth of ESG investing has pushed many companies in sectors ranging from fossil fuels to tobacco to transition in recent years, to change their public image and continue attracting investment. Companies such as Shell are high-profile examples of firms which radically altered their visions and plans due to pressure from institutional shareholders, with the adoption of more planet-friendly policies and championing diversity in their leadership teams.
Regulators have also supported the ESG agenda with more verve in recent years. For example, the UK Government implemented reforms in 2020 that mean pension funds now have an explicit responsibility to integrate sustainability into their investment approach.
The COVID-19 pandemic has only served to accelerate ESG’s rise, with many retail investors re-evaluating their lives, including their current investments, and updating their portfolios in line with their social and economic values.
What has also persuaded investors to focus on ESG investments has been the poor performance of traditionally preferred stocks such as commercial property during the pandemic, giving ESG investments the opportunity to grow from fringe players to star performers.
The strong performance of these ESG assets – renewable energy in particular – has shifted the perception of ESG from ‘nice to have’ to an investment that is likely to generate alpha for investors. As a result, according to Morningstar, money invested into ESG funds rose to $71.1bn between April and June 2020, pushing the total invested in these funds to over $1trillion globally.
The right selection
However, despite the growing success ESG investors are having, it can still be difficult to plot the right investment path, with sustainable investment jargon making choosing a suitable investment portfolio a sometimes-confusing process. The term ESG itself can be interpreted in a variety of ways and each investor will have a personal criteria when it comes to sustainable investing. For example, investors need to look at whether the company pays their staff fairly; but how do you define fair pay? Others will look at whether the company has net-zero carbon emissions; but is their supply chain ethical? As a result, it’s no surprise that first-time investors can be overwhelmed about how they can choose a portfolio that meets their criteria before they’ve even started.
With confusing terminology and ambiguous definitions in many cases, investors can also get sucked into FOMO-induced losses, where an investment is made off the back of a previous year’s high performance without a long-term outlook. With ESG growing at such a fast-rate, it can be easy for investors to simply follow the performance of a company in the previous year without fully understanding the implications of the market.
Financial advisers can help explain the different sub-sections of ESG and assist investors in making the right investments, from low carbon companies, thematic investments such as clean energy and forestry, or equality-based funds. Advisers can also help clients to create investment plans which don’t just pay lip service to sustainable investing trends, but that actually meet the needs of the investor.
Additionally, to help investors avoid just jumping on the latest ESG bandwagon, advisers should select ESG investments just like traditional funds or stocks, which are chosen and are valued in a sustainable and fair way. This is done by looking for large-cap companies with strong brands or up and coming businesses with difficult to replicate business models.
ESG is set to stay firmly at the top of the agenda for investors and managers – it’s a shift that shows no sign of slowing. However, selecting the right assets that don’t just pay lip service to a growing trend can be challenging for investors, particularly inexperienced ones. To guide investors along the way, financial advisers are on hand to provide the clarity and knowledge which helps investors find assets that meet investor’s ambitions, views, and goals for the future while also delivering returns.
This article was first published in the May 2021 issue of Professional Paraplanner.