Published: 31 May 2019
Responsible investing may previously have been seen as a niche activity, but there is now growing evidence to suggest that it can help future-proof your portfolio, making it more sustainable for the longer term.
One possible misconception is that responsible investing is about cutting out ‘bad’ companies and investing only in ‘good’ ones. In reality, however, an increasing number of mainstream funds now take environmental and social governance (ESG) factors into consideration when they are investing in any company1.
Far from excluding entire sectors, this means funds are focusing on companies and sectors that take account of their impact on society, the environment and have good governance (in areas such as pay, corruption and board diversity for example).
By using ESG criteria, funds are putting a greater emphasis on sustainability - in other words, they are seeking to future-proof their investments.
Nearly four in 10 global investors already have some sustainable investments in their portfolios2, the UBS Investor Watch survey recently found, while 82% of investors believe returns from sustainable investments will match or surpass those of traditional investments3.
Companies themselves are also taking ESG criteria more seriously, perhaps in response to increased scrutiny by investors and fund managers. Just over 70% of analysts polled for the Fidelity Analyst Survey 2019 said firms were increasing their emphasis on ESG policies4.
There are already a myriad of Ethical, Socially Responsible, and Impact Investing funds out there and these are just a few of the categories that are marketed to investors who want their investments to align with their principles.
Where ESG differs is that the criteria are increasingly being factored into the decisions made by fund managers across all their funds, not just those labelled ‘ethical’ or ‘socially responsible’.
One of the reasons for this is a growing policy shift towards sustainability, amid greater awareness of the economic consequences of issues such as climate change and inequality.
For example, in 2017 the Law Commission called for pensions schemes to be transparent about their stewardship policy and how ESG factors are considered in relation to investment decisions5. From October 2019 pension scheme trustees will be obliged to consider ESG factors in investment decisions6, under new government legislation, while the Financial Conduct Authority has opened a discussion on similar requirements for workplace personal pensions7.
Many ESG approaches build on the UN’s Principles for Responsible Investment, which offer guidelines on how ESG issues should be incorporated into investment practice8. The guidelines are followed by more than 2,200 signatories accounting for over $82 trillion (£61.8trn) in assets under management, including some of the world’s biggest pension and investment houses9.
What this all means in practice is that, whether you know it or not, you’re increasingly likely to have money in pensions and investments that put their money into companies seen as being sustainable and having a positive impact on the wider economy.
For instance, funds using ESG criteria might be more likely steer clear of companies which have poor corporate culture and which therefore may be at greater risk of regulatory penalties. A high-profile example within the past few years is the impact on Volkswagen when it emerged that it had cheated on car emissions tests10.
The theory is that if a company demonstrates a positive culture, a commitment to sustainability and good management, it is more likely to avoid scandal. It may also signify a forward-thinking company able to withstand the challenges of the future.
This might be a simplistic way of looking at it, but evidence suggests there may be some truth in it. Companies with better ESG standards typically perform better financially and beat their benchmarks, research by data firm Axioma found last year11.
Other research found that the MSCI KLD 400 Social index has outperformed the S&P 500 since 1990, despite being restricted to companies with ‘strong sustainability profiles’12.
Past performance is, of course, not a guide to future performance and ESG investing is still in its relative infancy. But in an era in which awareness of the impact of governance is growing and the causes and effects of climate change are more widely understood, it seems inevitable that the move of ESG into mainstream investing is only going to gather pace.
And for long-term investors especially, that also seems likely to be good news.
This is provided for general information only and takes no account of personal circumstances. It is not a recommendation to buy or sell. It is provided solely to support you in making your own investment decisions. If you have any doubts as to their suitability you should seek expert advice. Alliance Trust Savings does not give financial or investment advice.
Laws and tax rules may change in the future without notice.
Please be aware that the value of investments can fall as well as rise so you could get back less than you invest. Past performance is not a guide to future performance.
1 Morningstar - More Funds Add ESG Criteria as Sustainable Investing Grows - 4 April 2019
2 FT - Fund buyers to increase ESG exposure - 29 April 2019
3 UBS - UBS Investor watch: Return on values - 2018
4 Fidelity – ESG now pervasive in Europe and growing in China – 22 February 2019
5 Law Commission – Pension funds and social investment
6 FTAdviser - Pension schemes mandated to disclose ESG risks - 11 September 2018
7 New Model Adviser – FCA to require climate change disclosure for pension schemes – 15 October 2018
8 UN PRI - What are the principles for responsible investment?
9 UN PRI - PRI CEO Fiona Reynolds addresses meeting at G20 - 5 December 2018
10 FT - The Volkswagen scandal shows that corporate culture matters - 13 January 2017
11 FT - Companies with strong ESG scores outperform, study finds - 12 August 2018
12 FT – Sustainable investing can propel long-term returns – 18 September 2018
Alliance Trust Savings Limited is registered in Scotland No. SC 98767, registered office, PO Box 164, 8 West Marketgait, Dundee DD1 9YP; is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, firm reference number 116115. Alliance Trust Savings Limited gives no financial or investment advice. ‘Alliance Trust Savings’, ‘ATS’ and 'AT Savings' are all brand names of Alliance Trust Savings Limited together with the ‘Alliance Trust Savings’ logo are owned by and used with the permission of Alliance Trust PLC, the previous owner of Alliance Trust Savings Limited.