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ESG criteria and considerations
Sustainable funds are not all the same
Environmental, Social and Governance (ESG) factors are the three pillars of sustainable investing. As such, fund managers will typically consider the following within these three areas when analysing investment opportunities:
- Environmental issues – how a company is addressing issues such as climate change, resource depletion, waste, pollution and deforestation
- Social issues – a company’s policies and record in relation to human rights, modern slavery, child labour, working conditions and employee relations
- Governance issues – a company’s record in relation to bribery and corruption, executive pay, board diversity and structure, political lobbying/donations and tax strategy.
A potential issue for investors is that sustainable funds adopt different policies and investment approaches. SRI Services, an independent and specialist business with over three decades of experience in sustainable investment, has developed a set of ‘SRI Styles’ in order to make comparisons easier:
Sustainability focused
An investment approach that focuses on identifying companies that offer products and services that encourage greener lifestyles or show sustainability leadership. Funds adopting this approach typically avoid sectors that don’t help raise environmental and/or social sustainability standards, as well as arms and tobacco companies.
Environmentally focused
An investment approach that focuses on environmental opportunities – from single issues like water, resource management or waste, to broader issues such as biodiversity and climate change.
Socially focused
An investment approach focused on people issues – from employment and education, to diversity, equality and human rights. Funds adopting this approach invest in companies with positive social practices.
Ethically focused
An investment approach that focuses on issues relating to personal values or opinions. Funds adopting this approach typically invest in companies with more positive environmental and social practices and avoid areas that are widely regarded as more negative – like arms, tobacco and gambling.
ESG weighted
An investment approach that considers environmental, social and governance (ESG) or sustainability issues, but isn’t wholly directed by them. Funds adopting this approach tend to favour companies with higher ESG or sustainability standards. They will typically invest more heavily in those that have higher ESG ratings/standards or scores and less heavily in companies with lower ESG ratings.
Limited exclusions
An investment approach that will only limit investment in, or exclude a small number of, companies such as tobacco companies or companies that breach commonly adopted ESG standards. They may aim to encourage companies to improve their standards.
Faith based
An investment approach that focuses on faith-based issues (e.g., Sharia Law). Funds adopting this approach tend to use negative ethical screening to invest in assets that align with a recognised religion or faith. Other funds may also be suitable for investors of faith, although their core focus is not religious beliefs.
Implications when recommending funds
Some clients may be satisfied that a fund is managed on a broadly sustainable basis. Stocks from certain ‘sin’ sectors may be included, for example, if the company has demonstrated that their ESG credentials are moving in the right direction. However, due to ethical, moral or religious considerations, other clients may state that certain stocks or industry sectors should be avoided completely.
It is therefore important to check a fund’s investment approach and policy on exclusions before making a recommendation.
In our
Adviser Guide to Sustainable Investing, we examine the various types of funds and approaches in more detail.
Adviser guide to sustainable investing
To aid your client discussions, we’ve produced a guide that explains all things ESG to your clients.
Sustainable investing glossary
Our glossary defines some of the more frequently-used terms in this field of investment.
Sustainable Investment Finder
Our tool is designed to make the process of selecting sustainable funds easier. Take a look at how it could help to identify potential fund solutions, whatever a client’s sustainable outlook may be.