What is ESG Investing?
Environmental, social, and governance (ESG) investing represents a way of sustainable investing that takes into consideration ESG factors. ESG investing is based on the idea that environmental and social factors are leaving a stronger impact on the financial performance of corporations and organizations.
This method of investing adheres to environmental criteria which gives importance to how a company protects the environment and corporate policies focused on climate change and human well-being. ESG investing also considers strict social criteria which analyse the relationships between the company and its staff, customers, suppliers, and so on.
Finally, it also follows governance criteria that address a company’s executive pay, audits, leadership, and shareholder rights, among others.
How does ESG investing work?
As ever, investors allocate their funds to assets with the highest-return potential. Given the growing importance of ESG factors in recent years, global brokers and mutual funds have started launching exchange-traded funds (ETFs) and other financial tools that adhere to ESG investing criteria.
ESG-based ETFs and mutual funds hit a new high of $400 billion in assets under management (AUM) in 2021, marking a 33% year-over-year growth. This trend is expected to continue gaining traction in the future. Furthermore, industry reports showed that investors held $17.1 trillion in ESG-related assets in 2022, up from $12 trillion in 2018.
The coronavirus pandemic played a major role in stimulating this trend as market turmoil drove numerous investors toward ESG-specific funds to provide more portfolio stability. In the first three months of 2022, ESG-specific funds saw inflows of $45.6 billion.
Incorporating ESG into your Portfolio
Incorporating ESG considerations into investment strategies is rapidly becoming a must for accessing capital. While investors continue showing more interest in ESG investing, many face issues related to how to actually incorporate ESG into their portfolios. Below are two key factors to consider.
Primarily, investors must specify their ESG beliefs and then decide how much ESG they wish to incorporate.
One of the key steps to consider when incorporating ESG is active ownership. This method, which can be implemented via proxy voting or company engagement, has proven to be an efficient way to mitigate ESG-specific risks while maximising return potential and maintaining a positive social and environmental influence.
Secondly, it is essential for investors to ensure they hire fund managers that can properly incorporate ESG factors into their portfolios. For this reason, it is important that their investment consultant thoroughly understands the importance of ESG factors and knows how to evaluate investors’ ESG capabilities.
Big money managers have been adopting ESG investment principles quite slowly over the past decade, but that trend has been picking up steam much faster in the more recent period. Rising concerns over immediate threats looming over global economies and the planet, such as climate change, have brought asset managers to a turning point.
That said, asset managers around the world are now facing a difficult challenge that involves developing a sustainable business model around the new age of ESG-specific investments.
Future of ESG investments?
It is clear that ESG investing will keep gaining traction in the future as investors continue to show an appetite for sustainable investment funds. There are several factors driving this trend, making it highly unlikely that ESG investing is a short-term movement.
Both individual investors and the largest money managers are increasingly shifting portions of their portfolios toward ESG-specific investments as they seek ways to use their money to help build a more sustainable world.
While ESG investing dipped in 2022 due to a tough environment, it is widely expected that investors should return to ESG investing as the market recovers and the global investor sentiment improves.
Talk to one of our experts at Finsbury Wealth to discuss whether ESG Investments is a smart investment opportunity for you to diversify your portfolio and take advantage of compounding gains in the long term.