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Getting the language right: Understanding ESG investing

Sapna Patel explains that ESG-aware investing can take many different forms. Greater education and clarity will enable Future Pensioners to invest in ways that resonate with their beliefs.

Is it only millennials who are ethically-conscious when it comes to investing? According to a recent YouGov poll cited in the FT, millennials are “twice as likely as older generations to want their pension to be invested responsibly”. However, the same article points out that assets held in ethical funds have tripled in the last 10 years to £16.7 billion, suggesting such issues must resonate strongly with a much broader range of savers, too.

So it’s vital that Future Pensioners understand the approaches available, to ensure they really are investing in things they feel comfortable with.

People use terms like ethical, ESG (Environmental, Social and Governance), sustainable and impact investing almost interchangeably, but there can be big differences, and it pays to make informed choices. As a brief rundown:

  • Ethical investing – is where moral judgments governing asset choices are applied irrespective of the effect on performance. For example, an ethical fund may rule out investments in companies that test products on animals, manufacture weapons or rely heavily on extracting or burning fossil fuels, regardless of whether they could generate high returns.
  • Responsible investing – is where ESG considerations are taken into account but do not drive decision-making, and the financial motivation for investing remains paramount. For example, a fund may choose to invest in a company developing alternatives to plastics because it believes its business model has growth potential. Equally, however, it may seize an opportunity to invest in a plastics company if it believes shares are cheap following a mass sell-off of plastics stocks.
  • Sustainable investing – is where investments are restricted to things that are compatible with the long-term sustainability of the planet, society and the economy. Using the example above, a sustainable fund may decide not to invest in a plastics manufacturer, even if the stock is cheap, because it doesn’t feel that plastics have a long-term future.
  • Impact investing – is where a fund invests in things specifically designed to benefit society or the planet (rather than ones which simply have no negative effect), for example by improving access to health, education or green energy or by helping to reduce waste.

It’s clear that “ESG investing” could mean different things to different people, and products under this broad umbrella may vary significantly in approach. Savers should get their definitions right, and then choose appropriate investment products accordingly. Trustees and providers should make a range of options available, and make sure members are aware of them.

Could ESG investing ever become the norm?

As demand for ESG investing grows, there’s a huge amount of innovation going on in the market, increasing choice. The first step in enabling Future Pensioners to embrace ESG investing is getting these new ESG-aware funds onto the right platforms so they can be offered by employers. However, this won’t be enough on its own.

There’s also scope to become more experimental in how we research Future Pensioners’ views to understand what they really want, and to communicate more clearly what all the different funds actually offer so they can judge which ones meet their requirements. We may then see members accessing a broader range of ESG-aware funds, with sustainable and impact approaches becoming more mainstream.  

For now, we need to stop conflating the various ESG investing terms and start educating Future Pensioners as to what these different terms mean, in a practical sense. Helping members to understand these differences is vital if we are to help them invest in ways that meet their broader objectives.

Currently, most DC members are invested in default funds, where the emphasis is not on social or environmental issues. Rightly, the focus of Trustees and providers is on offering a default that delivers good financial returns for members. However, responsible investing – which considers ESG factors in order to protect and enhance returns – is fully aligned with this objective. Hence there is a strong case for making responsible investment the norm in default funds, helping to deliver good returns as well as being in step with evolving member views. 

Then this trend of ESG investing may really take off.