Environmental Social Governance (ESG) investing

Find out what ESG investing is and how it works. So you can choose investments that match your goals and values.

What ESG means

ESG investing is when a fund considers sustainability (including environmental, social and governance factors) to inform their investment strategy.

There is a growing demand for ESG investing, also known as sustainable (or sustainability-related), responsible or ethical investing.

The way ESG is defined may differ from fund to fund. It can cover a range of factors, such as:

• Environmental – air and water pollution, biodiversity, carbon emissions, clean technology, climate change, deforestation, energy efficiency, sustainable agriculture, waste management, water scarcity
• Social – child labour and labour standards, community relations, diversity and inclusion, ethical product sourcing, gambling, human rights, Indigenous reconciliation, tobacco
• Governance (of investment or companies in supply chain) – board diversity, bribery and corruption, business ethics, corporate culture and conduct, whistle-blower schemes

Before you invest, make sure you understand the fund’s ESG investment strategy. They can vary greatly. If there’s anything you’re not sure about, ask the fund.

How ESG investing works

An ESG fund aims to maximise financial returns for investors, while pursuing its ESG investment strategy. A fund’s ESG investment strategy may include one or more of the following investment approaches:

Screening investments

A fund may screen investments by:

• Negative screening: excludes investments that don’t meet certain ESG criteria. For example, one fund may reject all investments with exposure to gambling (‘absolute’ screen). Another may accept some exposure to gambling. But reject those companies which earn, say, more than 20% of their total revenue from such activities (screen is subject to a ‘revenue’ threshold).
• Positive screening: seeks investments that satisfy certain ESG criteria. This may mean choosing investments that are not necessarily performing better than their sector peers based on ESG factors. For example, a fund may give each investment a score. Then consider the score, along with other relevant ESG criteria, when choosing whether to include the investment.

ESG integration

ESG integration is when a fund considers ESG risks and opportunities in the decision-making process for each asset it considers for investment. A fund may consider ESG risks and opportunities, before including an investment. For example, a fund may consider the risks of climate change and the opportunities of transitioning to renewable energy across its investment strategy.

ESG impact investment

A fund may invest in order to achieve an ESG goal or outcome, like affordable housing or clean energy sources. Or target themes, such as low carbon emissions or sustainable agriculture.

Corporate engagement

A fund may select investments to influence changes in a company’s conduct on ESG-related matters. For example, as a shareholder of the company, it may seek to bring about change by voting at meetings.

Important: Greenwashing is when a fund says its product is more sustainable or ethical than it is. It’s marketing spin. For example, a fund promotes itself as avoiding investment in tobacco products. But doesn’t publicise that it may invest in companies who earn revenue of up to 20% from tobacco products.

Check that what a fund says about investing with it matches what it is actually doing.

Before you invest in an ESG fund

Ask yourself these questions before you invest.

Investment product labels

Look at how the fund describes the investment product:

• What words or labels does it use? For example, sustainable, ethical, green, environmentally friendly, responsible, conscious, or impact investing.
• Are these words defined? Does their meaning match your understanding?

Investment strategy

ESG products will differ across the market. Check the approaches each fund takes in its investment strategy. For example:

Screening investments

• If the fund uses negative screening, check the PDS, additional information guide, sustainability report and website for any stated exceptions.
• If it uses revenue thresholds, is ‘revenue’ defined and are the threshold levels clear? Check when the threshold levels, and any exceptions, apply.
• Are companies with indirect involvement in a controversial sector allowed under the screen? For example, a screen that excludes tobacco products may allow investing in retail stores that sell cigarettes.
• If the fund uses positive screening, does it clearly explain when an investment is included?
• Is it clear what percentage of underlying investments are covered by each screen?
• If a screen relates to only part of the underlying investments, is that consistent with the ESG claims made by the fund?
• If the fund discloses underlying investments or a sample, do these holdings match how the fund screens? If not, this might be an indication of greenwashing.

ESG integration

• Do you understand how the fund considers ESG factors, risks and opportunities when it makes investment decisions?

ESG impact investment

• Is the impact investing strategy defined by the fund? Is it clear which sectors or themes are the fund’s focus?
• Does the fund explain the methodology that assesses the potential impact of each underlying investment?

Corporate engagement

• Does the fund explain how it influences change?

Look for this information on the fund’s website or in the product dicsloure statement (PDS).

Match with your investing goals

Consider your investing goals:

• What ESG factors matter most to you?
• How much weight will you give these factors?
• Does the fund or product align with your investment goals or the ESG issues you care about?

Not sure about how to choose investments to fit your goals? See choose your investments.

Management and fees

Some funds charge you higher fees for an ESG investment, than for a non-ESG investment.

Check how the fund manages the investment and what it will cost:

• Is it actively managed? So, the fund has direct oversight of it. This may cost you more.
• Or passively managed? For example, the product replicates a particular index or it invests wholly in another financial product. This may cost you less.

Case Study

Cara suspects greenwashing

Cara wants to invest to support a healthier world.

She sees an ad for an investment called Zero Tobacco Fund, which says: “The Zero Tobacco Fund contributes towards achieving a healthier world for our investors and the global population. The fund avoids significant investments in tobacco companies.”

In the fine print on the fund’s website, it also says: “From time to time, the fund could invest in companies involved in the manufacture, sale and distribution of tobacco products that earn less than 50% of their total revenue from tobacco activities.”

She asks the fund for more information to support these claims. She finds that the fund:

• doesn’t have a clear investment strategy to achieve its social impact goals
• doesn’t define what ‘a healthier world’, ‘significant investments’ or ‘total revenue’ means
• by using ‘from time to time’, is vague about when it will invest in a tobacco company

Cara wonders if the fund is greenwashing by overstating the social impact of the investment. She decides this isn’t the right investment for her.

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Source:
Reproduced with the permission of ASIC’s MoneySmart Team. This article was originally published at https://moneysmart.gov.au/how-to-invest/environmental-social-governance-esg-investing
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