ESG investing rests on three pillars. These are environmental concerns, social actions and appropriate governance. Although at first glance you might think these play second fiddle to financial performance, they’re increasingly important and ESG is becoming a viable investment sector. I’d say that over the past year, this area has really taken off. Companies are also recognising the benefit of being ESG-friendly. So how exactly can I capitalise on this growing trend?
What makes a company ESG-friendly?
The three elements of ESG investing are quantifiable. Environmental concerns can be seen by the way the company manufactures its products, even down to the packaging. The social side of ESG can be looked at from the extent of workers rights and pay. Governance is down to how well the management team runs the business and oversees the other two points.
After reading the above, it’s clear that some companies can more readily show ESG credentials and this is my first smart way of buying in to the ESG trend. For example, let’s say I’m deciding between two companies for ESG investing. One is an insurance business, the other is a manufacturer. The manufacturer can commit to being net-carbon-neutral in production, reducing other emissions and more. The insurance company will struggle to show the same level of response simply because it doesn’t have a large impact on the environment in the first place.
There’s nothing wrong with this, but as an investor I could get enhanced returns from buying shares in a company that can more readily show improvement from the angle of ESG. If it’s clearer to the market and well publicised, it could see a share price bump.
More ways to go about ESG investing
One of the easiest ways to get exposure and make investments in ESG-positive firms is via a mutual fund. Various ESG funds exist and simply track the performance of a collection of stocks that are deemed to be ESG-friendly. Popular stocks are Unilever and AstraZeneca. In this regard, it takes out the homework needed. I can buy in to a ready made portfolio and simply watch the results.
The downside of buying such an ESG fund is that I don’t have the ability to tailor it. If there are companies in the fund that I don’t like, or some missing that I would rather buy, I can’t tweak the specifications. This is down to the fund manager, and I don’t have control over this.
Another way of going about ESG investing is trying to spot companies before management makes a large commitment to the cause. Companies that I feel could do a lot more include Scottish Mortgage Investment Trust (in terms of the stocks in which it chooses to invest) and Royal Dutch Shell. They have a huge opportunity to take a step forwards in the near future and are likely to do so.
Given the trend of ESG investing, I expect more companies to actively make changes to appeal to this portion of investors. So buying shares in companies now that could do more, may preempt a future rally in the share price.
Overall, I think it’s clear ESG investing is here to stay. So either buying into a specialist fund or looking for future ESG stars I think is the way to go.
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jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.