Earth Day 2022: How to invest in our planet

Friday is Earth Day.

A constant in the drive for awareness and policy change for the last 51 years, in 2022 it is expected to involve more than a billion people in 192 countries.

This year, the focus is investing in our planet. But when it comes to the financial world, plagued by perhaps the most rampant greenwashing of any industry, that seems a deliberately difficult task.

There is no doubt that we as savers, spenders and investors now expect environmental consideration to underpin the portfolios of those we entrust with our money.

Research from Triodos Bank shows nine in every 10 investors expect their fund managers not only to divest from harmful industries but also to directly challenge the companies they invest in on sustainability.

Eight in 10 also expect them to up their own game, upskilling in sustainability and environmental issues to avoid greenwashing claims from financial providers.

We have been putting our money where our mouths are too – in no uncertain terms. More than 40 per cent of European fund assets now sit in ESG funds, according to Morningstar – a huge shift in only a few short years.

In the UK alone, £33.5bn went into environmental, social and governance (ESG) equity funds in 2021, data from Refinitiv Lipper shows, dominating the overall market by some margin.

Crucially, recent short-term dips in performance – as growth stocks have floundered and oil and gas companies have profited from rising energy prices – aren’t deterring us, either.

“The performance tide has turned against ESG funds of late. That won’t stop money flowing into responsible investments though,” says Laith Khalaf, head of investment analysis at investment platform AJ Bell.

“There is genuine consumer demand for these products, and the investment industry has sunk a lot of marketing dollars into launching new funds and rebranding existing ones, which now carry the ESG tag. On top of which, longer term performance of ESG funds compares favourably to more traditional offerings, especially in the global fund sector.”

The problem is though, that this is all still pretty new, and the infrastructure to protect and support investors has been hastily erected – though regulator the Financial Conduct Authority (FCA) is about to introduce a much needed green labelling regime.

There are some basics we can all follow to avoid those funds and brands that are simply jumping on a bandwagon without actually changing a damned thing at ground level. They include selecting funds provided by those with a long track record in ESG and whose investment products – and the research resources behind them – are largely, if not entirely, ESG oriented.

A couple of ESG funds in a sea of others isn’t fooling anyone anymore, particularly when the simple fact is that natural capital underpins every aspect of every economy anyway.

But what about the myriad strategies and tools used by those ESG funds? And how do we navigate the fact that “sustainable” remains a highly subjective label?

“As things stand, there are a number of different approaches to investing ethically. Some funds will combine a number of these different approaches, and within each approach there is a spectrum of ESG activity, from weak to strong,” says Khalaf.

“It just goes to show that if you do wish to invest ethically, you do need to roll your sleeves up and look under the bonnet of prospective funds if you want your fund to be ticking a lot of the right ESG boxes. You might not get a perfect match, but you can certainly find a fund which is significantly more aligned with your ethical preferences than the market as a whole.”

Exclusions

Most of us assume, when we talk about ethical investing, that we mean excluding certain industries from a fund’s portfolio – usually tobacco, oil and gas, gambling and defence companies. This might suit investors who don’t mind too much where they invest, as long as their money isn’t held in companies which they believe are doing harm. This is a traditional, straightforward way of investing ethically.

ESG integration

Here, ESG factors are considered when making investment decisions, with varying effects. For instance, a fund manager could simply receive an ESG rating for each stock, alongside other financial information which informs their investment decision. The ESG rating may therefore be a very small part of the overall decision-making process, and hardly reflected in the portfolio, which is why this approach is the target of so many greenwashing accusations.

Tilting

Some funds use ESG scores to tilt their portfolio away from companies with poor ratings, and towards companies with good ratings. This approach clearly means that some of your money may still be invested in some companies and industries which you might take issue with, but you’ll have a significantly lower exposure than the market, so it strikes a balance between ethics and pragmatism.

Best in class

Here, we’re talking about a fund with holdings across a range of industries, even carbon intensive ones, but picks a portfolio of companies which are leading their sector in terms of their ESG credentials. That makes it easier to produce a balanced portfolio, and would probably suit those people who believe the likes of BP and Shell are critical to the transition to cleaner energy.

Stewardship

Stewardship basically means looking after the investments you manage from the point of view of the environment, society, or the economy at large. At its weakest level this would mean simply voting on proposals made by portfolio companies, at its strongest it would mean lobbying investee companies for change, either in private or in public, or both. It’s probably hard to find an active fund that couldn’t claim to engage in some form of stewardship, so it’s a pretty broad church. Stewardship is an important component of responsible investing, but in ESG funds it would normally be supplemented by further measures.

Positive impact

Some funds go a step further and seek out companies that are actually working towards solving some of the ESG problems facing the world, whether that be climate change, financial inclusion or poverty. These funds can be more risky, often because they can invest in fairly specialist areas. Indeed, included in this category are funds which target investment in specific themes, such as renewable energy, or clean water. This could be the way to go if you’re determined that your money does no harm, though it can result in very focused portfolios.