Harvey Jones
16.12.2020

Everybody wants to save the world. Is ESG investing the way to do it?
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Everybody dreams of saving the world. We've all thrilled at that movie where the hero averts global conflagration with seconds to spare, and wished we could do that, too.

Well now investors are being given a real life opportunity to save the planet, using their retirement portfolios.

Luckily, you don't have to tangle with villains and you won't be alone, millions of investors just like you are being called upon to take action, too.

The idea is that we harness our wealth to do good, by investing in companies that help the planet rather than harm it.

While underlying principle is admirable, saving the world through the power of investing is not without risks. It could interfere with what is still your primary goal, which is to build sufficient wealth for a comfortable retirement.

Can you do both?

Green not mean

There is nothing new to ethical investing, as it was originally called. The concept first emerged in the US in the early 1970s, while the first UK ethical fund Friends Provident Stewardship was launched back in 1984.

It has gone through several name changes since, including green, sustainable and socially responsible investing (SRI). Today, the phrase to use is environmental, social and governance investing, which is horrible, frankly. Call it ESG for short.

ESG is this year's big thing. Barely a day goes by without a fund manager launching a fresh batch of funds, hoping to capture the zeitgeist (and your money).

It has been given an extra push by the pandemic, which has focused minds on the wider threats facing mankind.

Advocates hailed a tipping point in January, when the world's biggest fund manager BlackRock announced it was overhauling its investment strategy to make sustainability the “new standard”.

Chief executive Larry Fink said ESG investing now makes economic as well as social sense, because companies can no longer ignore climate change risk as it poses a real risk to their long-term viability.

The question is how individual investors should respond. My answer is this: with caution.

Vegan surprise

First, choosing an ESG fund isn't easy, because every fund manager has a different view of what it entails.

Some will screen out companies and sectors they believe cause social or environmental harm, such as tobacco, armaments or fossil fuels. Others take a "best in class" approach, which means they may invest in an oil company that is working to cut its carbon footprint.

The greenest target companies that are actively trying to do good, such as those involved in renewable energy and cleaner water.

You cannot simply buy a fund branded SRI or ESG and feel good about yourself, you have to be sure its principles match yours.

Ethical funds may contain hidden surprises. For example, last year’s biggest ESG holding wasn’t a solar farm or recycling company, but tech behemoth Microsoft, according to financial data company EPFR.

Microsoft is aiming to be “carbon negative” by 2030, but is that enough? Google-owner Alphabet was in second place, followed by Disney and Apple.

Similarly, the US Vegan Climate ETF numbers Apple, Facebook, Microsoft, MasterCard, Visa and AT&T among its top 10 holdings. Surprised? I was.

Strike the right balance

Any fund you buy also has to match your existing holdings. For example, the Vanguard ESG US Stock ETF is more than 30 per cent invested in US technology stocks. Its top five holdings are Apple, Microsoft, Amazon, Alphabet and Facebook.

Given recent runaway US tech performance, you may already be heavily exposed to this sector, and vulnerable to a correction.

Ethical-minded investors might also ask themselves if Amazon and Facebook really meet the “social” element of ESG, when one is blamed for destroying jobs, the other for giving a platform to hate speech.

As you can see, it's not easy being green.

Does performance match up?

The biggest issue is performance. Saving the planet is a tall order and you don't want to trash your retirement along the way.

Critics say that by shrinking your investment universe you may also shrink your returns. They have gone quiet lately, though, as ESG has outperformed.

The MSCI’s All Country World ESG Index sector beat its non-ESG benchmark over the last five years, growing 94.6 per cent against 91.3 per cent.

However, a major factor is the falling oil price. US oil giant ExxonMobil was once the largest company in the world. In 2007, its market cap peaked at $500 billion. Today, it is a fraction of that at around $170 billion.

Stock markets move in cycles, though, and oil stocks could snap back if Covid-19 vaccines do their work, and people start driving and flying as before (and you can bet they will).

Other companies that struggle to meet ESG criteria, such as the big banks, may also rebound when the pandemic eases.

Measured over 10 years, ethical funds have underperformed, growing 173 per cent against 252 per cent for mainstream global funds.

You may still have to pay a price for your principles.

Another way to save the world

Carbon emissions, sustainable energy, and climate change are important issues but ultimately, they must be resolved through collective government action. I’m not convinced your portfolio needs to be on the front line of this fight.

A better way of saving the world might be to maximise your investment returns, then divert some of the profits to good causes close to your heart.

That way you can still do your bit for the planet, while knowing exactly what good your money is doing.

Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.

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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.