ESG fund speed dating: the key questions to ask to find your match

by Faith Glasgow from interactive investor |

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ESG funds have never been more popular with investors. Our guide narrows down the playing field to help find a fund that best meets your own values.

If you don’t know what ESG stands for in the world of responsible investment, or what it actually means for the way funds may be run, you are by no means alone.

A survey of 500 savers carried out by financial adviser The Private Office in September found that while 85% of respondents would like to invest responsibly, more than half (56%) had never even heard of the term. Moreover, only one in four (24%) knew what ESG investing involves: hardly a reassuring figure for the experts trying to boost the profile of socially responsible investment (SRI) options.

For those not in the know, here’s what you need to know. ESG is an acronym for environmental, social and governance – factors that many SRI fund managers will look at when they assess companies as potential additions to their portfolios.

These considerations are nothing new for ethical investors; but what has really piqued broader investor interest in the past couple of years is the argument that companies with a strong focus on managing ESG issues effectively and responsibly tend to be more robust businesses as a consequence anyway. Therefore, the previously deeply entrenched view that returns must be sacrificed in order to invest ethically or sustainably now looks redundant.  

The difficulty is that even if you sign up to the SRI concept and understand the terminology, responsible investment funds can take numerous forms, and it is important to be clear how they differ when you’re making your choice. Below, we outline the main categories, based on the groupings proposed by the ethical investment information hub SRI Services and used in its online ethical fund directory, Fund EcoMarket.

Negative screening

These funds apply a filter to their universe to weed out companies operating in a range of sinful sectors such as armaments, animal testing, tobacco, alcohol, pornography, fossil fuels, or in countries with controversial human rights records. But the lists can vary significantly: for instance the Schroder Responsible Value UK Equity fund selection process includes negative screening but has almost no environmental screen in place, and as a consequence has holdings in BHP (LSE:BHP) and BP (LSE:BP.) – unusual stocks to find in an SRI fund. So do look at the list of exclusion criteria before you invest.

Negative screening can be used in isolation - for example SRI-focused index trackers typically follow sub-indices that simply screen out undesirable exposures from the index.

Balanced screening

A more nuanced approach adopted by some funds is to combine exclusions with positive screens. This approach recognises that many companies score highly in some respects and less so in others, or are trying to do the right thing within a relatively unsustainable industry, so it involves balanced judgements by the fund manager, often across a wide range of industries. The Rathbone Ethical Bond fund is one that makes use of positive and negative screens and a best in class approach.

Thematic strategies

These are funds with a specific investment focus. Some - for example Liontrusts Sustainable Future series - are sustainability-themed, looking for the leading companies showing leadership in social and environmental practices, or delivering solutions that will help improve the world.

SRI Services has recently started differentiating between different levels of sustainability, as founder Julia Dreblow explains.

She says: “We now have sustainability themed for funds that really focus on forward-looking sustainability themes and build their strategies accordingly; and sustainability tilt funds that are relatively conventional but bring sustainability into their processes in order to make better investment decisions.” A well-known example of the latter is Baillie Gifford Global Stewardship.

As well as sustainability-themed funds, there are others that focus specifically on environmental issues, either a single theme such as climate change or renewable energy, for example Pictet’s Clean Energy fund, or (more often) as part of a range of themes, looking for companies with high standards or leadership, for instance Impax Environmental Markets investment trust (LSE:IEM).

A small number of funds or trusts take a similar approach to social themes: social bond funds fall into this category, as does the Syncona investment trust (LSE:SYNC).

How to find funds to meet your own values

Some fund managers are more committed to responsible investing and have embedded an ESG-focused approach throughout their whole fund range: Montanaro is a good example. Others, among them Aberdeen Standard, EdenTree, Rathbones and Jupiter, are particularly active in regard to “investor stewardship”, involving shareholder votes and manager dialogue, to get companies to improve their practices.

Bear in mind, some ESG holdings can be contentious. For instance, some funds invest significantly in “best in sector” oil companies and the FAANGs – areas where investor opinion remains divided as to their appropriateness for any kind of SRI portfolio. 

The next difficulty for investors is to work out which funds most closely suit their own personal preferences and values. One relatively simple way to do that is using interactive investor’s ethical hub. There you’ll find a full list of all retail funds, investment trusts and exchange-traded funds (ETFs), sorted by geographical focus and asset type, that are badged as having an SRI aspect.

Importantly, each has been assessed and allocated to one of interactive investor’s three categories: Avoids, Considers or Embraces. Within these groups, each fund’s Fund EcoMarket category is also shown, so you can get a clearer idea of its approach and investment focus. 

interactive investor has an ethical long-list and an ACE 40 list. The latter highlights high-quality ethical options that interactive investor believes offer the best choices for investors across a wide variety of markets. The ACE 40 list was recently expanded from the ACE 30, which was launched a year ago.

So, which type of socially responsible fund is most likely to suit you?

1. Is your primary focus on avoidance of ethically sinful stocks - tobacco companies, weapons manufacturers, polluters, human rights abusers?

2. Are you keen to use passive funds rather than active?
If the answer to either question is yes, you’ll probably want to look at the Avoids category of funds on interactive investor, although some negative screening is widely used in conjunction with other strategies.

3. Do you want to invest in funds with a specific investment theme, investing in businesses involved in mitigating climate change, protecting the environment or social housing?
If that’s the case, look at the Considers options, but specifically the environmental or socially themed options.

4.  Are you less bothered about a tightly focused theme and would instead prefer to invest towards the general move to find sustainable solutions for global problems?
If so, a broader sustainability themed fund may fit the bill.

5. Are you interested in finding a fund with a policy of active shareholder engagement to change company behaviour for the better?
You’ll find these impact-focused funds under the Engages list.

6. Do you want to be sure that your money is invested in businesses with strong ESG track records?
The ESG-plus category identifies funds that look closely at companies’ ESG risks and strengths typically as part of a wider responsible investment strategy.

7. Do you have very specific environmental, social or ethical concerns that you want to be sure are addressed in any investment you opt for?
Help is at hand, if so. Fund EcoMarket has a valuable tool that – among various other filters – allows you to drill down in into funds’ policies and interests in great detail.

It is possible to filter by policy, issue or theme, so that you could, for example, pull up funds that exclude alcohol production, invest in social housing, avoid investment in fracking, Arctic drilling or fossil fuels, or favour cleaner, greener companies.

8. Are you short of time or patience, and wanting an off-the-shelf SRI package to get you started?
If you feel a bit overwhelmed by the complexities of this fast-moving sector, interactive investor has pulled together a simple balanced, diversified Ethical Growth portfolio of 10 funds, including a suggested weighting for each. It could be used as it is; or as a best ideas list from which to supplement your mainstream portfolio; or as a jumping-off point or core for an SRI-focused portfolio, to which you could add funds targeting particular themes in which you are more interested.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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