ESG investing is gaining popularity with environmental, social and corporate governance aspects of a company’s performance having taken on increased prominence.
Here’s a practical framework I’d consider using when choosing shares for my portfolio using an ESG investing approach.
Focus on sectors first
I’d make a shortlist of possible ESG investing picks by zooming in on a few sectors. I’d focus on those that match my understanding of what ESG represents.
And that may not necessarily mean going for the obvious. For instance, oil majors Shell and BP have been increasingly focusing on alternative energy sources in recent years. Still, in broad terms, I would start by focusing on sectors whose core focus seems in line with ESG principles. For example, recycling strikes me as more environmentally friendly than burning fossil fuels.
Select some possible ESG investing picks
Next, I would look into possible choices within the given sector. For example, there’s a range of listed companies involved in some form of recycling, including Biffa, Renewi, D S Smith and Augean.
As an investor, I generally try to choose what I think could be a winning sector first. Then I try to discover the companies within that sector that look like they have the best prospects. I would do the same here, and narrow down my choices to just a few options in each relevant sector. As always, I use diversification to reduce my overall risk.
In this stage, I would focus more on the investment case than how strong the company’s ESG credentials are.
Read up on ESG performance
Next, I would research the company’s ESG credentials. That will help me weed out some choices from my shortlist.
Parts of this process are easy, but there are also complications. It’s easy because there’s more such information available than ever. Companies often now publish dedicated reports on this topic. A company’s annual report typically includes ESG information too.
But the difficulty comes in making an accurate judgment. A company reporting its own performance lacks the credibility of an objective third-party assessment, in my view.
A second challenge is that ESG investing is a broad concept. For example, a company could have excellent corporate governance practices but still be very socially damaging. So when digging into the detail on ESG performance, I find it helpful to be clear about what I’m looking for exactly.
ESG investing: virtuous circles not virtue signalling
Ultimately, as an investor, my primary focus is financial return.
However, like many people I would prefer to invest in companies that have genuine, positive social and environmental impact. As an investor, I see no value in empty ‘virtue signalling’. Instead I look for companies with what I regard as a virtuous circle: socially and ethically-conscious behaviour that in turn can help the bottom line.
Unilever is an example. I think its ESG credentials can actually make its products more attractive to its customers. That should help profits, although there is a risk that extra costs could reduce profitability.
In short, I focus first and foremost on a share’s financial prospects. Sometimes these are actually helped by an ESG approach. If I can apply ESG investing principles and still discover such shares, I would consider buying them.
christopherruane owns shares of Unilever. The Motley Fool UK has recommended DS Smith and Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.