The last few years have seen a surge of interest in environmental, social and governance (ESG)-focused funds. These assess potential investments’ success in cutting carbon emissions and improving racial or social diversity and governance.
Two subcategories of the ESG strategy are socially responsible investing (SRI) and impact investing. When it comes to SRI, investors actively favour sectors such as healthcare or renewable energy and avoid businesses such as tobacco firms.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Running the numbers
ESG investing relies heavily on numbers-led screening based on data sets frequently provided by established market-data firms, such as MSCI or IHS Markit.
There is some debate about how these are constructed, where the data is sourced from (usually the reporting firms) and why it varies so significantly.
The self-reporting of data has prompted experts’ calls for uniform, perhaps even legislated, accounting standards. Other critics point to the relative lack of data on social statistics. Very few screens look at CEOs’ pay, wage differentials or labour representation.
Many ESG strategies lean heavily towards equities with a growth bias that favours technology companies. This has helped many ESG funds to outperform “conventional” equities in the last few years.
But as Vincent Deluard of US-based investment house StoneX observes, the trend has created a skew towards companies that overpay CEOs, employ fewer staff than their old-economy counterparts, invest less in capital expenditure and pay less tax. Tens of billions of pounds are flowing into ESG funds, partly due to their eco-friendly selling point. But there is a strong chance that both the energy complex and old-world cyclical industrial companies will significantly outperform the new world of ESG stocks in the coming months and years.
This could undermine ESG funds’ appeal, especially if the clean-energy stocks – which look overpriced on several measures – start to depreciate sharply. London-based fintech Util argues that ESG is a broken model and that we need to replace it with something else. Cue SRI and impact investing.
Finding alternatives
UK-listed investment trust Menhaden Resource Efficiency (LSE: MHN) launched in 2015 with a broad sustainability strategy. It made mistakes and its share price languished before the board narrowed its focus to profiting from the efficient use of energy and resources. This is a much more interesting remit and the fund is trading at an unreasonable 25% discount to its net asset value (NAV).
Impact investing carries risks, because many of the businesses likely to have an impact may not be very well established. But an excellent example is Home Reit (LSE: HOME), which generates an income by renting out property to the homeless and those struggling with addiction problems, thereby achieving a direct, quantifiable, social outcome.
Combined, these could constitute a socially responsible part of your portfolio. Forget the all-encompassing ESG approach and set a few objectives. Identify the impact outcomes you’d like to help achieve, then find funds that focus on this. Schroders and Big Society Capital are already backing specialist funds such as their joint Social Impact Trust. Concentrating on a few impacts might mean you don’t tick every box: a business that focuses on emissions reductions may not have a great record in other areas. But you can help make a discernible difference.
-
Zoopla: House sales fall for first time in two years as buyers wait for Autumn BudgetThe average price of a house in September was £270,000, down £1,000 from August as the housing market’s Christmas slowdown came early, Zoopla says
-
Number of high-earning women jumps 12% – how to convert income into pensionsMore women than ever are paying the highest rate of tax as record numbers succeed in high paying professional roles. But their pension saving still needs to catch up
-
Yoshiaki Murakami: Japan’s original corporate raiderThe originator of Japanese activism, Yoshiaki Murakami, was disgraced by an insider-trading scandal in 2006. Now, he's back, shaking things up
-
Cash in on the vast growth potential of the companies electrifying the worldOpinion Martin Todd, portfolio manager, head of sustainable equities, Federated Hermes, highlights three electrification companies where he'd put his money
-
Galliford Try has firm foundations for strong growthBuilder Galliford Try has a finger in a wide range of pies, notably important work in the public sector
-
Card Factory is a stand-out small-cap going cheapIn a digital world, we still value the personal touch. That’s good news for Card Factory, whose unique business model is suited to weather all economic storms
-
8 of the best smallholdings for sale nowThe best smallholdings for sale – from a medieval cross-passage farmhouse in Taunton, Somerset, to a former farmhouse with an orchard in the Welsh Marches
-
How much gold does China have – and how to cash inChina's gold reserves are vastly understated, says Dominic Frisby. So hold gold, overbought or not
-
How to invest in undervalued gold minersThe surge in gold and other precious metals has transformed the economics of the companies that mine them. Investors should cash in, says Rupert Hargreaves
-
Debasing Wall Street's new debasement trade ideaThe debasement trade is a catchy and plausible idea, but there’s no sign that markets are alarmed, says Cris Sholto Heaton
