ESG investing: a checklist for beginner investors

There may only be room for one Greta Thunberg but if you want to invest for good, be prepared to do your research.

Could you give up flying to save the planet? Barring Greta Thunberg, I suspect most of us - me included - would squirm at the thought. That is why a Guardian headline 'I didn't want to fly - so I took a container ship from Germany to Canada' caught my eye. I wondered if the writer was retired, or a teacher with long holidays. How else would you manage a 15-day transatlantic crossing?

It turns out the writer was travelling home to Vancouver from Germany for Christmas. The account of their sea and rail voyage is fascinating, and there is no attempt to flysgskam (flight shame) the rest of us. But the data has the last word: the carbon footprint was 209.5kg vs 1.3 tonnes for a plane ride. However, the below response from a member of the Twitterati offers a swift reality check.

Still, I cite The Guardian article because it is an admirable – saintly even – example of how behaviour is evolving in light of the climate crisis. Thankfully, there are less extreme ways of “doing your bit” that do not involve travel by cargo ship. I am talking about ESG (environmental, social and governance) investing.

The environmental strand of ESG relates to a focus on firms’ environmental policies. The social element addresses areas such as the avoidance of child labour and human rights in the supply chain, while the governance factor focuses on how companies are run. This takes into account transparency of information, finances, and the treatment of shareholders, for example.

As I have written before, I am a beginner investor with one fund in a stocks and shares ISA. However, I am considering a new, separate investment. Yet as I have started to research ESG investing options, I have found that it is not at all straightforward. At first, I struggled to tell the difference between 'ethical investing' and ESG investing. The former is a more classic term that relates to investments that avoid firms involved in tobacco, alcohol, pornography, gambling and animal testing, for example. But ESG is a new, nuanced acronym. So, given my confusion, here is a checklist for other beginners.

50 shades of green: there are many different interpretations of what used to be badged as ethical investing (surprise, surprise, some investment managers interpret it to their advantage) and lots of additional terminology. As well as 'ESG investing' (environmental, social and governance), there is language such as 'positive tilt' and 'impact investing'.

Therefore, if you are considering ESG investing, you must do your research to make sure you understand what the positive-sounding terms sprinkled across websites and brochures actually mean. It is important to understand that there are investments with a general ESG slant, meaning fund managers consider ESG factors when assessing firms to hold in the portfolio, and then there are investments that concentrate on firms that are actively trying to solve the climate crisis.

For those on the lookout for an investment that backs environmentally focused companies, there are two specific sectors within investment trusts: environmental and renewable energy. But it is currently difficult to identify trusts in the more mainstream sectors (such as those that invest in UK shares or global shares) that have a general ESG slant. When it comes to funds, though, it is much easier for investors to pick out the ESG options. This is because organisations such as Morningstar, a research company, flag the ESG good practitioners on their websites.

Heroes and villains: the most common approach is to avoid - or 'screen out' - the 'bad guys'. For example, not investing in fossil fuel firms, alcohol, pornography, tobacco, weaponry and gambling. But be aware that other fund managers will work under a 'best in sector' approach, which means they could include a fossil fuel company in their fund, for example, if it is actively trying to do good and has, say, carbon emissions goals. See what I mean about things being nuanced?

Beware greenwashing: this term is used when those who are managing investment funds try to present their products as green to investors. Some investment groups have an ESG approach that is more deeply embedded than others, such as Royal London, Liontrust (LSE:LIO) and Stewart Investors. 

Getting started: if you are exploring ESG options, Money Observer's annual Your Fund Choices guide provides a list of high-quality investment funds, trusts and exchange-traded funds (ETFs) – including ESG choices.

Show me the money: In December 2019, I wrote a piece on the top 10 ethical investment funds of that year by performance (the returns on your investment). If you compare the returns with the year’s top 10 funds overall, it gives you a rough idea of the difference between ESG and non-ESG investing. But it is important to think long-term and remember the industry adage that says past performance is no guide to future performance.

Little by little: as Greta Thunberg said, “No one is too small to make a difference”. Just as individuals have a choice over what items to buy or boycott, so do they in terms of what they invest in, and this power should not be “misunderestimated” (to quote a famous Texan).

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.