Every generation tries to find their voice and leave their mark on society. The greatest generation went to war, the baby boomers embraced social change, Gen X battled against the AIDS epidemic and gave rise to the age of computers, and now millennials and Gen Z are at the forefront — shaping the future of our world.
CNBC reports that millennials have been a driving force in the growth of sustainable investing throughout the 2010s. They also found that approximately 33% of millennials will only make Environmental, Social, and Governance (ESG) fund-compliant investments.
According to Morningstar, as an increasing amount of Gen Z reaches adulthood, and an age at which they can consider making investments, ESG factors aren’t a consideration — they are a priority.
But what exactly are ESG funds and what does this all mean for your clients?
It is essential that your clients stay apprised of the changing social landscape as it can help them make informed investing decisions. Shifts in the greater population’s approach to investing can have a direct effect on the markets.
As ESG funds become more common in the marketplace, it is vital that your clients understand what they are, their benefits, and downsides.
Read on to discover if ESG investing might be the right move to keep your clients on track to meet their long-term goals.
ESG funds hold businesses accountable to ethical criteria
ESG funds are made up of businesses that have passed an assessment by an external agency that focuses on environmental, social, and governance criteria.
These non-financial factors are used to determine if an investment or company is sustainable and run in an ethical manner. Once an agency has assigned an ESG rating, investors are then able to use the score as a guide to ensure their investments align with their personal beliefs and morals.
Environmental factors might focus on a company’s carbon footprint, social factors might assess how it tackles social issues such as LGBTQ+ discrimination, and governance factors typically consider how ethically a company is run.
ESG criteria typically focuses on areas such as:
ESG investing can act as a tool to encourage companies to adopt ethical corporate policies and push them to act more responsibly.
If your client has strongly held beliefs regarding the environment, social progress, or the governance of corporations, ESG investing might be the right move for them.
As the “green economy” is likely to grow in the coming decades, as climate change issues force more companies to adopt ESG guidelines, it will probably become a larger part of your client’s future portfolio.
ESG investing could align your client’s portfolio with their values
The primary driver of ESG investing is that it puts your client’s beliefs, values, and goals at the forefront of any investing decisions.
An ESG rating can hold companies accountable and push them to meet the criteria outlined. It pressures them to be mindful of their business practices and acts as a “red flag” for investors to avoid unethical companies — whose actions may eventually lead to them facing serious financial repercussions at a future date.
Some recent infamous examples of unethical business’s bringing about serious consequences include the Lehman Brothers involvement in the 2008 subprime mortgage crisis and Volkswagen’s emissions scandal — two incidents that sent their respective companies’ stock prices tumbling and cost both firms billions.
ESG criteria could reduce the risk associated with your client’s investments.
ESG investing could generate greater returns
Beyond the obvious ethical benefits, ESG investing might lead to greater returns for your clients.
A 2019 white paper by Morgan Stanley discovered that the total returns of sustainable funds were typically on par with traditional funds when assessed over a period from 2004 to 2018.
Other studies have gone further and shown that ESG investments can outperform conventional ones. So, once social benefits are factored in, ESG funds can seem increasingly beneficial.
Morgan Stanley’s white paper also found that in times of instability and volatile markets — such as 2008/9, 2015, and 2018 — traditional funds showed greater losses on average than sustainable funds.
In the UK, the sector has seen significant growth in recent years with Growth Capital Ventures reporting that, between 2018 and 2021, UK ESG start-ups saw a 127% increase in investment.
The problem with ESG investing, and how to avoid greenwashed businesses
The rapid growth of ESG investment funds in recent years has made it difficult for external agencies to keep up with assessing the validity of companies’ claims that they’re truly ESG compliant.
Some unethical companies have used “green” terminology and branding to give their businesses’ the illusion of being sustainable and ethical. This issue is known as “greenwashing”.
Aviva reports that greenwashing is a pivotal issue when debating the benefits of ESG investing and includes a valuable checklist for potential investors.
- Investigate any fund beyond just its name as many companies will use buzzwords such as “sustainable”, “eco-friendly” or “green” to come across as compliant at first glance, while actually failing checks behind the scenes
- Research potential investments and their fact sheets and key investor information documents to review their stated aims and past performance
- Review the company’s ESG policy, how well it scores, and whether it aligns with your values
- Find their annual reports and see if there is ongoing accountability towards meeting ESG targets
- Speak to a financial planner and decide which funds meet your ethical and financial goals.
After your clients have done their due diligence and are certain a business is ESG compliant, it is still vital for them to be aware that opting to invest in ESG funds can limit their portfolio’s options and make diversification more difficult.
There are many major industries such as oil, tobacco, or defence that will be unlikely to fulfil ESG criteria – yet are industries that can potentially see very high returns for investors.
ESG investing also comes at a premium with many funds proving to be more costly investments on average.
However, if your client views their closely held values as essential to any major life decisions, they could see a benefit from ESG investing regardless of the investment’s performance.
Get in touch
Investing with a conscience and opting for an ESG fund can have benefits that extend beyond the financial.
If your client has strongly held views and wants to generate growth in a way that aligns with their core values, they should seek advice and email us at firstname.lastname@example.org or call us on 0345 505 3500.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.