What is ESG investing?
ESG – environmental, social and governance – investing is related to the criteria that allow investors to put money into companies that take sustainability and ethical impact into consideration.
With several terms associated with investments that prioritise the planet and society as much as they do financial performance, it’s worth a closer look at the sector and how it can help your investment strategy.
Investors are no longer focused solely on long-term financial returns – they’re increasingly considering the wider impact of their capital on the world and society. Terms like sustainable, responsible and ethical investing are often used to describe this shift, though they’re not always interchangeable.
There’s arguably been a perfect storm of political and economic forces affecting the sector. Between 2018 and 2022, demand surged as the Paris Agreement aligned global climate policies, regulatory support improved and investment flooded into sustainable strategies. By 2022, 86% of asset owners surveyed by the London Stock Exchange Group (LSEG) said they were “evaluating or implementing” sustainable investing practices, up from 53% in 2018.
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Since then conditions have shifted. Russia’s invasion of Ukraine drove up energy prices and turned attention towards energy security and defence, while inflation and economic uncertainty have overshadowed long-term sustainability goals in some markets.
At the same time, rising costs and more complex regulations have made ESG funds more expensive to run. This, alongside changing investor preferences that favour short-term trends and market cycles, has contributed to outflows, according to Julia Dreblow, founder of SRI Services and Fund EcoMarket.
What does ‘ESG’ stand for?
‘ESG’ has evolved from a niche concept to a mainstream investment consideration since the term was coined in the United Nations’ (UN’s) 2004 report ‘Who Cares Wins’.
Once viewed as a trade-off between values and returns, many investors now recognise the relationship between sustainable objectives and performance is more nuanced.
Companies have placed greater emphasis on corporate social responsibility (CSR), embedding ESG considerations more firmly into the investment landscape and potentially supporting greater resilience against long-term risks like climate change.
Performance, however, depends heavily on timeframes and sector dynamics. Sustainable funds outperformed traditional peers over the five-year period to 2024, but many have lagged more recently given higher interest rates and exclusions to sectors such as fossil fuels. That said, opportunities within energy and defence may warrant a more selective approach at company level.
While enthusiasm has tempered, Robeco argues ESG is not 'dead', as some commentators have suggested, but has instead corrected, with investor sentiment remaining broadly stable despite geopolitical pressure and shifting priorities around areas like cybersecurity and infrastructure.
What type of investments does ESG cover?
It’s a broad and complex area, with many variables and definitions.
‘E’ – or environmental element – look at companies’ climate and sustainability implications. This includes carbon footprints, resource use, waste management and progress towards net zero.
The ‘S’ – social – typically spans issues affecting stakeholders including employees, suppliers, customers and local communities. This can include human rights, fair wages, diversity and working conditions.
The ‘G’ – or governance – covers company leadership, transparency, accountability, board composition and executive pay.
There is no single way to apply ESG criteria to a portfolio but most fund managers use a combination of three approaches.
Negative screening excludes certain sectors or companies, such as tobacco, defence stocks or fossil fuels while positive screening seeks businesses that perform well on ESG measures or contribute positively to sustainability goals.
Stewardship takes a more active approach, with investors using their influence as shareholders to encourage better practices through voting, dialogue and monitoring progress against targets. Advocates argue it’s hard to influence a company if you don’t have a ‘seat at the table’.
Impact investing goes a step further by targeting measurable social or environmental outcomes alongside financial returns, such as renewable energy projects or businesses addressing social challenges.
ESG is not limited to equities. Fixed income also plays a role, typically through green or ethical bonds, which fund projects or issuers meeting certain sustainability criteria.
How to invest in ESG or sustainable funds
Investors have several routes into ESG or sustainable investments.
If direct shares are your thing, it might be worth using an independent research tool like MSCI ESG Ratings or Sustainalytics from Morningstar to check how they rank certain companies.
Consider your screening criteria in light of the above – negative or positive screens, or impact, for example. Cross reference this with the company’s individual ESG or sustainability reports – often published alongside or referenced in their annual report, found in the investor relations section of company websites. You may also find additional ESG-related information on your chosen trading platform.
Explore funds and model portfolios that integrate ESG considerations (sustainable options are often offered alongside platforms’ main ranges).
On the equity income side, one actively managed constituent of Hargreaves Lansdown’s Wealth Shortlist is Janus Henderson UK Responsible Income Fund, with an ongoing charge figure (OCF) of 0.85%.
If you’re looking for actively managed bond funds, some options include Aegon Ethical Corporate Bond, Columbia Threadneedle UK Social Bond, Rathbone Ethical Bond or Royal London Ethical Bond.
Each will focus its support in a different direction but these typically back targeted projects, companies or government initiatives that are local or national in reach.
If you prefer passive funds, Legal & General offer several with different regional tilts – Legal & General Future World ESG Tilted & Optimised UK, World and Emerging Markets portfolios. Each tracks its respective Solactive L&G Enhanced ESG Index and combines stewardship, ESG integration and exclusions.
A couple of more concentrated, thematic ETFs are Wisdom Tree Renewable Energy UCITS ETF or the Invesco Hydrogen Economy UCITS ETF, while a broader index fund is the Vanguard ESG Developed World All Cap Equity Index Fund. In fixed income one highly regarded tracker is iShares ESG Screened Overseas Corporate Bond.
Elsewhere, government-backed options like National Savings and Investments (NS&I) offer green savings bonds – fixed rate bonds that allow you to lend money to the government to fund green projects like wind power or zero-emission buses.
How have ESG funds performed?
Performance remains one of the most debated aspects of ESG investing. According to Morningstar, global sustainable funds recorded net outflows of around $27 billion in the fourth quarter of 2025, following nearly $55 billion of outflows in the previous quarter, with large UK institutional clients accountable for a “substantial” share.
But Morningstar this did not necessarily indicate declining interest, with money moving from pooled ESG funds to bespoke mandates.
Returns have also been uneven. Using UK indices as a proxy, ESG-focused stocks have lagged the broader market in recent periods. Over five years, Morningstar shows the UK Target Market Exposure index returned 78.2%, compared with 32.2% for its UK Sustainability index.
But short-term performance and fund flows don’t always tell the full story. Broader asset allocation trends often have a significant impact, particularly as ESG funds are often concentrated in specific sectors or styles.
Dreblow said investors remain concerned about environmental and climate issues but broader market shifts disproportionately affect ESG strategies.
“This isn’t people necessarily turning against sustainability. People don’t want sea levels to rise, see fires everywhere and other extreme weather events. People care. But if there’s a shift away from equities and a shift away from the UK, that will make a difference,” she said.
”These things swing and they will swing back again.”
What’s the regulator’s position on ESG?
In recent years, the Financial Conduct Authority (FCA) introduced Sustainability Disclosure Requirements (SDR) to help consumers better understand and compare ESG investments, while tackling concerns around greenwashing – where ESG-related claims cannot be substantiated.
Dreblow said SDR was well-intended but challenging in practice, arguing the level of granularity required around fund labels meant compliance was difficult for many managers, especially when portfolios change over time.
The FCA has also consulted on its future approach to regulating ESG ratings, with findings expected later this year, and a new ESG ratings regime due to come into effect in 2028.
Dreblow said during the boom into sustainable investing a few years ago, many ratings agencies had limited access to environmental and social data, meaning assessments were skewed towards the ‘G’ because governance intelligence was easier to access due to previous legislation.
The roots of ESG stretch back much further. Ethical investing principles can be traced to religious movements that avoided so-called ‘sin stocks’ linked to weapons, alcohol or gambling.
In 1984, Friends Provident launched the UK’s first ethical fund, marking the first overt opportunity for investors to align moral values with investment objectives.
