What is ESG?
ESG stand for Environmental, Social and Governance, and it’s an attempt by the industry to offer ethical funds. But does this matter, and does it work?
The Environmental part measures things like the company’s carbon footprint, their treatment of animals, their energy use and their sourcing of raw materials.
The Social part covers their adherence to health and safety legislation in the workplace, whether they partner with the local community, their support of charities.
The Governance bit is about issues like gender balance on their board of directors, following good practices like separating the Chairman and CEO roles, their use of political donations and there adherence to best accounting and reporting practices.
Lots of investors would prefer to own ethical companies, and ESG funds are the industry’s response to consumer demand. An ESG fund will use a benchmark provider to give ratings on characteristics of a company’s operation, and poor-scoring companies will be excluded from the fund.
Exclusions
One problem with this is that not everyone has the same idea on what constitutes bad behaviour. While many investors would prefer not to own tobacco companies, the position of alcoholic drinks companies is less clear. At what point do we decide a product is harmful - if used at all, or if used in moderation?
The difficulty comes when we are excluding otherwise “good” companies for what could be considered flimsy reasons. Tesla generally has a reputation for being a “good” company on an ethical mission, trying to accelerate the transition to clean transport. But one benchmark provider recently excluded them on the basis of their poor staff relations.
So there is certainly a question mark on interpretation. Your ideas of what fits your ethics are unlikely to be a perfect match with those of the people curating an ESG fund.
Buying not Owning
It turns out that your ownership choices don’t impact the behaviour of companies anything like so much as your buying choices.
If you boycott British American Tobacco and refuse to own their shares, someone else will own them instead. Your boycott doesn’t really have an impact on them. If, on the other hand, you don’t buy their products, this dent in sales (when take together with everyone else’s action) Is keenly felt and will cause the management to pivot to trying to offer something which pleases the market and causes them to open their wallets.
In conclusion
It doesn’t really matter whether you choose an ESG fund or not. If it pleases you, then it probably won’t harm your returns greatly, and you should go with your conscience.
There will be some impact, however. You’re excluding some of the most profitable brands from your portfolio. According to a comment on the most recent course of the Rebel Finance School, one popular fund excludes seven out of the ten largest UK companies.
And of course the curators of ESG funds will charge you a little bit for their work, meaning that an “ethical” fund may well be slightly more expensive.
You will have a greater impact with your spending choices than by buying an ESG fund.