What do we mean by ESG investing?

Responsible investment is the practice of incorporating environmental, social and governance (ESG) factors in investment decisions

We define responsible investment as the practice of incorporating environmental, social and governance (ESG) factors in investment decisions. But what does that mean in practice? 

Examples of environmental, social governance (ESG) factors are numerous and change over time. Breaking down the acronym: environmental issues might include pollution, water use, and climate change; social factors may encompass  conduct and culture, diversity and human rights; and governance includes business purpose, executive remuneration, and board structures.

At PFA ethical, we’ll work closely with you to ensure that your pension is invested in funds that only include businesses that score highly on both financial and ESG criteria. The funds themselves are created by asset managers - such as Legal & General or Royal London  - who select the individual companies.


How would an asset manager incorporate ESG factors when selecting companies to include in a sustainable fund? 

Each asset manager would have their own approach, but here is an example how it often works in practice.  First, the manager would assess and select companies to include in their sustainable funds. Next, the  asset manager would screen companies for key ESG and financial factors. They could look at the strength of the management team, the strength of the balance sheet and the competitive advantage of a business. 

With every investment they make, the  asset manager would do a detailed Environmental, Social and Governance (ESG) assessment of that business. From an environmental perspective the team would look at things like the carbon intensity, water usage and other factors of the companies it invests in. From a social point of view, the team would  look at whatever they determine are the most important issues of the day, such as the taxation practices of the companies they invest in. When it comes to the corporate governance of a company, the team could look at remuneration and the structure of the corporate board to ensure they will act in shareholders’ best interests. 

The investment team could also screen out businesses in certain sectors or activities. In particular the fund could avoid investment in any company that is likely to be exposed to factors such as human rights abuses, tobacco production or armaments manufacture. The funds could  also avoid investments in companies that have significant trading interests in activities such as animal fur products, pornography, or worker exploitation and other exploitative consumer practices.

This screening process would then give a smaller subset of potential investments where the team carries out in-depth analysis on corporate governance, environmental and social performance, business quality and valuation. The asset manager would then apply a minimum threshold to both ESG and financial factors and ensure all investments in their portfolios score highly on both.

In short, asset managers create different funds consisting of companies that perform well on financial and ESG factors. It is then the job of the financial adviser to select the appropriate fund for an individual investor.

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