The Big Green Elephant in the Room

January 2022

Does a good ESG score always mean that an investment fund is sustainable or responsible?

Climate change, COP26, electric cars, greenhouse gases – pick your buzzword. We are being increasingly bombarded with messages from government and media about the impact humans are having on the planet and what they think we ought to be doing about it.

Not before time, perhaps, given that the past seven years have been the hottest on record*.

The investment management industry has been reacting to this, and this is potentially a good thing. Investing responsibly can be just as effective as any individual actions we can take, or even more so**.

The problem is that there is a lot of new terminology, much of which is not clearly defined, which can lead people to invest in funds that they think are behaving responsibly, when that may not necessarily be the case.

One abbreviation that you have probably encountered is “ESG”, standing for “Environmental, Social & Governance”. Very soon, all funds will be legally required to disclose their ESG rating, but does a good score always mean that a fund is making a difference?

It may come as a surprise to you to learn that it does not!

All it means is that a fund has screened the companies it invests in to find out where there are risks to investors from environmental, social or governance matters. It is a compliance and risk factor, nothing more than that.

That’s not to say it’s a bad thing. For example, if a company was heavily dependent on fossil fuels for its profits, there is clearly a risk that this would be affected by a future ban on petrol and diesel cars, and this is something that you as an investor should know about.

But a good ESG score does not always equate to a fund that is doing good. Independent analyst Worthstone considers a range of factors to establish the impact that investment funds are having, and they recently reported that of the 345 funds they analyse, the fund with the highest ESG score ranked 301 out of 345 for impact. It also owns significant shareholdings in companies involved in armaments and tobacco; one might not expect to find these in a fund with any sort of responsible or sustainable credentials, but they are perfectly at home in an ESG fund, because there’s not much financial risk in these industries.

If this is an area that concerns you, the goods news is that we are actively working with Worthstone and other companies to make available a range of portfolios that take account of the impact they are having.

If this is you, watch this space!

Our objective is for clients for whom this stuff is important to be confident that they can invest with a clear conscience, yet without having to compromise their investment experience. There are a number of trade-offs and the market is changing very quickly, so it’s not straightforward. But we are getting there.

Please do get in touch below if you have any observations or questions about this blog, or if you have a financial planning matter you would like some help on. One of our financial planning team will be glad to try and assist.

Important note: Investments can fall as well as rise, and past performance may not be a reliable guide to the future

* Source: ERA5 Copernicus Climate Change Service, reported by the Guardian and BBC News

** Source: Nordea Group Sustainable Finance research

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