ESG stands for environmental, social and corporate governance, the areas in which good behaviour is particularly sought.
Environmental, social and governance (ESG) investing – and similar approaches such as socially responsible investing (SRI) – aim to make money while avoiding firms viewed as having a negative impact on the world and encouraging those that have a positive impact.
Traditionally, ethical approaches to investing mostly focused on not buying any companies in businesses that the investor dislikes (known as exclusionary screening). This often included vice stocks, such as tobacco, gambling or alcohol. Some investors might aim to invest more in industries that they view as beneficial (such as renewable energy), although this was less common. However, as demand for ethical investing has become greater, this has evolved to include approaches where the investor takes into account whether a firm is trying to follow the highest standards they can within their sector. Hence an oil producer or a miner would not necessarily be ruled out in some funds or portfolios that follow ESG mandates, so long as the firm is attempting to minimise the adverse impacts of what it does. Some ESG investors will also engage with firms to try to pressure them to follow more sustainable practices, rather than simply not investing in them.
Environmental factors are probably the first thing that many investors associate with these kinds of investing strategies – from climate change to air and water pollution to biodiversity. Social issues are perhaps the broadest and the hardest to measure: they can include how the firm deals with customers, labour standards and human rights in its supply chain, or matters of gender, diversity and equal rights in its workforce. Governance is the strand that is most closely associated with traditional investment analysis: it includes issues such as executive pay, fair treatment of minority shareholders and questions of business conduct, such as bribery and corruption.
Clearly, ethical investing is subjective what one person finds inoffensive (alcohol, for example), another may consider uninvestable. And do remember that investing ethically is no good if it leaves you poorer than when you started. If you opt for an ESG fund over a simple tracker, make sure you have good reason to do so. If you're interested in finding the right fund, Monevator suggests looking at the Fund EcoMarket website.