Green is the new black. Or at least that’s how one of my colleagues described it, as we came out of yet another fund manager meeting and a presentation that ended with a slide on ESG. 
ESG is the acronym for environmental, social and governance: the three central factors used to measure the sustainability and ethical impact of an investment in a company or business.
Our research team meets about five fund managers every week. A couple of years ago, only a handful of these managers would mention ESG, and they would be the managers who have had it at the core of their process for decades. Today, however, nearly every single manager we meet makes reference to it.
While on the face of it is very encouraging, I have found myself questioning: is it just ‘greenwashing’? Are fund managers including this slide just because everyone else is, or because they truly believe ESG adds value?
Governance takes precedence
ESG factors are certainly more in the public eye today than they have been for some years. We’ve all talked about David Attenborough’s Blue Planet II. We’ve all seen the impact 16-year-old environmental activist Greta Thunberg has had recently. Gone are the days when global warming, water scarcity and a rapidly increasing global population bothered the minority to the ignorance of the rest. So there is certainly more public scrutiny.
But if you were to split up the acronym, it’s fair to say ‘G’ – governance – has so far led the way in terms of mainstream fund manager focus. This is perhaps because it is easy to see its importance from a commercial sense. If a company makes a poor decision; treats employees or customers unfairly or has unsafe practices, it will be found out. If twitter has taught us anything about transparency it is that.
But what about environmental and social factors?
A decade or so ago ethical investing was all about exclusion: avoiding companies that were involved in things like animal testing, oil drilling and cigarette production. But the overall conclusion was that if you invested in ethical funds you were set to lose out on the performance front due to the fact that when the oil majors or tobacco companies did well, these funds lagged. You had to sacrifice returns to adhere to your principles.
But that belief is simply not true. Many funds that have the ‘E’ and ‘S’ at the core of their process have managed to outperform consistently, over long periods of time, despite being divested from whole sectors in some cases.
And the number of companies that are addressing one or more of the environmental or social issues we have today is increasing exponentially. Whether it’s Starbucks encouraging us not to use single-use cups, or Nestlé now making a plant-based alternative to meats, the general direction towards better practice seems to be a permanent one.
How to sort the genuine from the ‘me toos’
But as an investor, how can you best determine whether a fund is genuinely looking at ESG factors or playing the ‘me too’ game?
There are a few questions we like to ask that give us an idea. The first is to ask for more detail on the ESG policy and for a report on company engagement. If they can’t be provided, it’s a dead give away that mention of ESG is just a marketing ploy, not an investment principle.
We also ask fund managers if they have decreased, divested completely, or increased a holding due to ESG considerations in the past 12 months. Actions, after all, speak louder than words.
Lastly, if a process involves scoring holdings in some way, we ask about the holdings with the lowest scores – why are they still deemed to be good investments? This tests the depths of ESG in the process.
Some of my favourite funds using ESG effectively
Pictet Global Environmental Opportunities is an option for those wanting to focus more on the E part of ESG. Since launch in September 2010, it has returned more than 146 per cent (10 September 2010 to 10 October 2019), outperforming the average global equity fund by some 12 per cent. At the heart of its process is the planetary boundary framework – the safe-zone we need to be operating in to make sure our planet is sustainable. Each company in the portfolio is actively contributing to solving environmental challenges.
Rathbone Global Sustainability is a relatively new option, having launched in July 2018. But it uses the same proprietary research and screening from its dedicated ethical and sustainable investment division, Rathbone Greenbank Investments, that has been used by Rathbone Ethical Bond fund successfully for more than 15 years.
Liontrust Monthly Income Bond isn’t an obvious choice – its name suggests no ESG connection for starters. But the team have had ESG at the core of their process for many years and, if it was launched today, I’m sure the name would be different. The managers of this fund are not trying to save the world, but they are trying to invest in companies that are going to generate excellent risk/adjusted returns – by acting appropriately.
My final choice is Hermes US SMID Equity – again not a pure ESG fund. However, Hermes funds across the board have ESG in their process and this fund is no exception. Run by mark Sherlock it is also a rare breed in that it is a US equity fund that has consistently managed to beat the market – in this case the Russell 2500 index.
There are a vast array of funds out there that could fit the bill. And I personally think that ESG is here to stay and that it will become more integral in more funds’ investment processes.
Darius McDermott is managing director at Chelsea Financial Services. The views expressed above are his own and should not be taken as investment advice.