Ethical Investing

Inflows to Environmental, Social and Governance (ESG) funds are accelerating rapidly. Funds in sustainable investments in Europe grew an explosive 58% to €668 billion between 2018 and 2019, according to Morningstar.

ESG funds (formally known as ethical investments) have been around for over 40 years, but the trend towards people wanting to align their investments with their values has been speeding up rapidly, fuelled by the popularity of climate activists such as Greta Thunberg.

This has sent fund managers into a frenzy; launching 360 sustainable funds in Europe throughout 2019, bringing the total to 2,405.

ESG funds invest in companies that align with a wide variety of ethical values. Environmental practices include those addressing pollution and climate change, Social practices such as those concerning human rights and working conditions, with Governance referring to the way companies run themselves, for example, through good practice on executive pay and anti-corruption.

Some funds in the ESG sector cover all these factors broadly, others focus on a specific aspect, such as the environment.

There are many standards and ways of meeting ESG criteria – a good manager will likely adhere to several standards. One of the most important and popular is the United Nations Sustainable Development Goals (SDG). These set criteria within 17 headline targets – from ‘no poverty’ to ‘reduced inequalities’ and ‘clean water and sanitation’.

How to Invest in ESG

ESG investing can also take several approaches:

  • Impact investing – funds companies that aim to make a positive difference, such as wind farms.
  • Inclusion – invests in all companies that meet certain ESG levels.
  • Exclusion – screens out companies that do not meet specific ESG criteria or have a negative impact, such as tobacco companies.
  • ESG Integration – incorporates ESG concerns into a predefined investment strategy.

Most ESG funds are still managed actively but passive funds are also gaining quickly popularity. Portfolio providers are also moving into this area with a range of risk-rated ESG offerings.

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Myths and Pitfalls

Contrary to what some critics say, there is extensive research showing that ESG investments have performed well against non-ethical peers.
For example, 2019 research from Morningstar found 73% of its ESG indexes outperformed their non-ESG equivalents since inception. There are still pitfalls, however. Some ethical funds have a bias towards mid and small-cap companies, which can be more volatile in the short-term.

A major pitfall is greenwashing – riding the bandwagon by making your fund sound more green or ‘ESG’ than it is – which many investors say is rife. One way to avoid these pitfalls is to outsource ESG investments to a portfolio provider with a reputation for thorough research.

EBI’s ESG Portfolios

EBI offers Earth portfolios – a diverse range of solutions that incorporate ESG criteria. The portfolios use ESG scores from Morningstar, which we believe provides the largest and most in-depth research in this area. The Earth portfolios only select ESG investments that meet all our evidence based principles.

It is a challenge to construct an ESG portfolio this way; the ESG criteria currently only apply to the equity part of the portfolios. It is expected however, that over the coming months and years, additional suitable ESG funds (including bonds) will become available for use in EBI’s Earth portfolios.