Too embarrassed to ask: what is ESG investing?

When we buy shares in a company or lend money to a company, we’re usually doing so because we expect to be able to grow our money more quickly than if we put the cash to use elsewhere. 

Some investors are content to focus on the idea of making a profit alone, but some investors might feel uncomfortable about profiting from the activities of certain companies. A classic example is tobacco. Cigarette manufacturers make their money by selling addictive products that are unquestionably bad for their users. Even if they can make good money by doing so, a significant number of investors don’t want to profit from that activity. Other investors may want to avoid fossil fuel companies, or weapons manufacturers, or companies that pay their staff poorly. This all comes under the broad umbrella of ethical investing. 

ESG investing – that is, investing with a focus on environmental, social and governance issues – is merely the latest incarnation of ethical investing. The main shift of emphasis with ESG is the idea that being a good corporate citizen actively benefits the bottom line. In other words, ESG investors argue that they aren’t sacrificing returns for principles. Instead, it increasingly makes sense to avoid companies that are linked to sectors or behaviours that society wants to move away from. It’s not hard to find practical examples. For example, a growing political emphasis on climate change and renewable energy has resulted in oil producers badly underperforming wind and solar power companies in recent years.

One objection however, is that there is little consistency in how ESG scoring is applied. There are many different ways to “screen” companies, and not all will throw up the results you might expect. Similarly, many companies have been accused of “greenwashing” – that is, paying lip service to ESG values for PR purposes, without actually changing any of their working practices. In short, if you genuinely want to ensure that an investment is compatible with your own values, you’re going to have to work much harder than someone who simply feeds their money into a stock market tracker fund every month.

• For more on how to be a more active investor, subscribe to MoneyWeek magazine.