As speaker after speaker at the COP26 summit in Glasgow has reminded us, global warming is a huge threat to the planet and requires immediate action. As we explained the other day, capital markets cannot solve this problem on their own; ultimately we need our governments to take the lead. But we can all play a part in tackling climate change through ESG investing — in other words, investing our money with the aim of producing social and environmental returns, as well as purely financial ones.
ESG investing is a hugely complicated subject. But, as usual, the body of knowledge that investors need to master is actually pretty small. In this video, JASPREET DUHRA, Global Head of ESG Indices at S&P Dow Jones Indices, explains the basic essentials.
Transcript:
Robin Powell: A type of investing we’re hearing more and more about is ESG investing — sometimes called sustainable or responsible investing.
ESG stands for Environmental, Social and Governance. So what exactly does it mean?
Jaspreet Duhra: Broadly what we’re talking about is trying to understand how a company is managing its environmental, societal, and governance challenges. Underneath that are potentially hundreds of sub-topics – so environmental could be climate, biodiversity; social could be human rights, labour rights; governance: what’s the independence like of the board? Have they got bribery and corruption procedures in place? So, on one level it’s quite a simple term – environmental, social, governance: ESG – but it can get very complex very quickly, and you have all sorts of investment styles that can sit underneath that.
RP: The impression we’re often given in the financial media is that, to invest in a sustainable way, you have to use an actively managed fund. But it’s not true. You can invest in an ESG index fund, and the fees and charges you pay will be very much lower.
JD: An ESG index is very similar to a mainstream index in the sense that it’s a rules-based, transparent approach to investing with this added layer of ESG. And that ESG can be very different things to different investors: so, it can be a simple exclusionary approach, it can be more complex approaches such as things like net zero, aligning with 1.5 degrees going forward. The key thing with an index is that we have to explain very clearly the approach that we take in creating such indices. We have to use very credible research, and the research piece is hugely important in an ESG index; and explaining the fact that these indices are not standing still. It’s not a case of: you’re in an index, and you’re comfortable as a company. There are requirements to keep monitoring those companies to make sure they are still strong from an ESG perspective.
RP: A complicating factor for ESG investors is so-called greenwashing. A fund might claim to be sustainable or ethical, but its actions might tell a completely different story.
JD: As we see more interest in ESG, there are more and more fund managers who want to get into the space. So there might be a temptation to label a fund as being ESG, or being green, and then not being able to substantiate that with the information that’s sitting underneath it. That’s a concern that many regulators have at the moment: you see a lot of that in the press. The EU are certainly trying to deal with what they consider to be a greenwashing issue, where funds are being labelled as green but there’s then maybe not the substance behind it. Green can be a plethora of things to different people, so how do you make funds easily available to the market, where it’s clear to investors what is sitting underneath the fund and, really importantly, how comparable they are to other green funds?
RP: As Jaspreet Dhura has explained, ESG investing is a big and complex subject. If you want to invest in that way, and there are very strong arguments for doing so, it’s best to use an adviser who really understands the subject. Not all advisers do.
MORE FROM S&PDJI
For more valuable insights from S&P Dow Jones Indices, you might like to read these other recent articles, or visit the Indexology blog:
Emerging markets: what investors need to know
Relative returns vs absolute performance
What if the last 40 years had turned out differently?
Picture: Fredrika Carlsson via Unsplash
© The Evidence-Based Investor MMXXI
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
