ESG investing: everything you need to know

ESG investing has gone from strength to strength in the last ten years, and is only set to grow. Find out what you need to know before you start investing in ESG shares here – plus how to get started and some top stocks to watch.

What is ESG investing?

ESG investing is a strategy for choosing stocks and funds that takes environmental, social and governance (ESG) practices into account. It involves assessing how a business is affecting the planet, its societal impact and how it is run.

The rising popularity of ethical and green investing has led more and more people to look beyond fundamentals when picking assets. But weighing up a business’ behaviour can be a tricky process – after all, there’s no single definition of what makes a ‘good’ company.

ESG is one method of assessing a stock beyond strict financial measures. It takes its practices into account as well, for a more cohesive view. If you’re interested in ESG investing, open a share dealing account to get started.

Why invest in ESG companies?

Some investors use ESG to find stocks that align with their values. They may, for example, prioritise companies that have a strong environmental record because they don’t want their capital to contribute to climate change.

Part of the reasoning behind ESG, though, is that a business’s behaviour across its three factors will impact its market performance. According to ESG investors, environmental malpractice, treating people badly or poor management will eventually hurt a company's bottom line.

Regularly underperforming against environmental regulations, for example, might incur a fine, loss of business or lack of interest from planet-conscious investors.

So ESG investors choose businesses that perform strongly across the strategy’s three headline factors, because they believe that these companies will outperform those that don't.

ESG divesting

Environmental, social and governance factors aren’t just used to pick new investments. Divesting is the process of exiting your position on assets because they perform poorly in ESG criteria. An ESG investor may sell their shares in a company if it starts failing certain environmental tests, for instance.

Alternatives to ESG

You may hear ESG used interchangeably with socially responsible investing (SRI) or impact investing. But while they all aim to achieve a similar goal, they are three distinct investment styles.

While it is a form of ethical investing, ESG doesn’t overlook financial performance. ESG investors believe that environmental, social and governance factors will affect a stock's future price at some point down the line.

Socially responsible investing goes one step further, choosing investments based solely on ethical criteria. Unlike ESG, it ignores financial analysis entirely: for example, by screening any stock that is involved in fossil fuels.

Impact investors, meanwhile, only allocate capital to causes that will have a positive outcome – such as clean energy.

History of ESG

The concept of socially responsible investing has a long history, but ESG is a relatively new concern. It has its roots in a report from 2005 entitled ‘Who Cares Wins’ by Ivo Knopfel, which made the case that businesses should pay more attention to ESG for both financial reasons and to support better outcomes overall.

The first studies that showed a correlation between corporate sustainability and financial performance were released in 2013 and 2014. A large number of fund managers and insurers got involved shortly after, and strategies soon emerged covering how to integrate ESG thinking into a traditional investment strategy.

Today, ESG investors have an estimated $20 trillion in assets under management.

Volkswagen

Volkswagen’s 2015 emissions scandal proved a controversial point in the growing adoption of ESG. Some noted that the company had slipped in its governance ratings from ESG agencies, which provided an early warning sign of the issues to investors.

However, many agencies had lauded Volkswagen as a strong environmental performer, unaware of its cars’ poor environmental performance. For many, this highlighted a flaw in the practical application of ESG.

What are the ESG factors?

The ESG factors are environmental, social and governance:

Let’s take a closer look at each.

Environmental

Investors, consumers and governments are placing renewed emphasis on climate change and sustainability. This factor examines the extent to which a company is taking a ‘green’ approach.

The number of potential criteria within the environmental factor is vast. It might, for instance, involve analysing how dependent a business is on fossil fuels, how much waste it is producing or how it treats animals. Alternatively, it might look at any significant environmental risks that a business is facing: such as if it regularly fails to meet government regulations.

Social

This factor examines how the company manages its relationships with people: including employees, suppliers, customers and local communities.

  • Employees. Criteria here might include whether a business has any diversity or inclusiveness policies, or how it treats its staff
  • Suppliers. This assesses the businesses a firm works with. For example, whether a phone manufacturer outsources production to factories with poor practices
  • Customers. Treating customers fairly is likely to have a long-term impact on performance. Criteria here may cover whether the business has sufficient consumer protection in place
  • Communities. Many consumers and investors want businesses to benefit society. So an ESG investor may look at whether a company helps people it doesn’t buy from, sell to or employ

Governance

The reasoning behind analysing a company’s governance practices is clear. A business that is run properly is more likely to succeed over the long term than one that isn’t.

When it comes to assessing a stock’s governance, common criteria can include:

  • Whether it uses open and transparent accounting practices
  • Whether shareholders can vote on important decisions
  • How much it pays its board – including bonuses
  • Board diversity
  • How much it spends on developing new products and services

Evaluating ESG stocks

Most businesses will perform stronger against some aspects than others, so if you’re considering ESG then you’ll need to prioritise stocks that align with the values you consider most important. One way of achieving this is to use the ratings from an ESG agency to examine how a company is performing against individual criteria for each factor.

Alternatively, you can invest via exchange traded funds (ETFs) or other funds that use ESG factors as part of their asset allocation. But much like individual investors, fund managers have to choose which criteria they’re going to focus on. So the principle here is roughly the same as choosing stocks – read the methodology of a fund you’re interested in to see whether its ESG aims match yours.

Name Country Corporate Knight rating MCSI rating
1 Ørsted Denmark

85.20%

AAA
2 Chr. Hansen Holding Denmark

83.90%

AA
3 Neste Finland

83.64%

AAA
4 Cisco Systems United States

83.59%

A
5 Autodesk United States

82.84%

AA
6 Novozymes Denmark

82.70%

AAA
7 ING Groep Netherlands

82.53%

A
8 Enel Italy

81.77%

AAA
9 Banco do Brasil Brazil

81.72%

A
10 Algonquin Power & Utilities Canada

80.89%

AA
11 Osram Licht Germany

79.87%

12 Sekisui Chemical Japan

79.48%

AAA
13 Storebrand Norway

79.32%

14 Umicore Belgium

79.07%

AAA
15 Hewlett Packard Enterprise United States

78.43%

AA

These are the 15 highest-rated stocks according to Corporate Knights’ ESG criteria, outlined in the Corporate Knights Global 100 report.

To create the report, Corporate Knights ranks listed companies around the world with over $1 billion revenue. They assess 21 ESG KPIs covering the management of resources, employees and finances, plus clean revenue and supplier performance. The report only takes publicly listed data into account.

Ørsted

Ørsted is the largest power provider in Denmark.

It was known as DONG Energy until 2017, when it changed its name because the old one was no longer correct. DONG stood for Danish Oil and Natural Gas, but the company has successfully moved away from fossil fuels in recent years. It no longer owns any oil or gas fields, has reduced its carbon emissions by over 80% since 2006 and has pioneered the use of offshore wind farms.

That devotion to the environment has seen the Ørsted named the best sustainability stock according to Corporate Knights’ ESG ratings, up from fourth position last year. The company performed particularly well in terms of water productivity, waste productivity and clean revenue, which measures the portion of income that has a clear environmental benefit.

Ørsted’s transformation has benefitted shareholders, too. Its stock has been on an impressive three-year run, climbing from 267DKK at the beginning of 2017 to peak above 760DKK in early 2020.

Chr. Hansen Holding

Chr. Hansen is a Danish biosciences company that supplies food cultures, probiotics, enzymes and natural colours to the food and pharmaceutical industries. It was Corporate Knights’ most sustainable business in 2019 but slipped one spot in 2020.

Over 80% of Chr. Hansen’s revenue contributes to the United Nations’ Sustainable Development Goals. It prioritises products that will benefit the environment, such as microbial solutions that can be used as a natural alternative to pesticides. That work has resulted in Corporate Knights giving it a clean revenue score of 100%.

Chr. Hansen stock peaked at 739DKK in mid-2019 after several years of growth.

Neste

Neste is an oil refining and marketing business in Finland, and the world’s largest producer of renewable diesel.

Neste scores highly in Corporate Knights’ ‘Innovation Capacity’ rating – which measures research and development spend – and thanks to the gender diversity on its board. This year marks the 14th consecutive year that Neste has featured on the Corporate Knights Global 100, which is longer than any other energy company.

Shares in Neste trade on the Helsinki Stock Exchange, and reached a new all-time high in February 2020.

Cisco Systems

The highest-rated stock outside Scandinavia on the Global 100 is Cisco Systems, the US tech conglomerate. It rose from 14th position in 2019, mostly by generating an impressive $25 billion in clean revenue. That’s more than 50% of Cisco’s overall revenue.

MSCI, another ESG agency, also rates the company highly: giving it an A. It did, however, highlight issues in Cisco’s supply chain.

Like Chr. Hansen, Cisco’s stock peaked halfway through 2019 but has struggled since, mostly down to a slowdown in the global economy.

Autodesk

Autodesk makes computer-aided design software for multiple industries: including manufacturing, engineering, construction and entertainment. It’s probably best known for AutoCAD, its flagship software.

The business scores highly for its energy productivity, taxes paid and investment in research and development (R&D). It has the highest proportion of women on its board of any company in the top ten (44%), and a staggering 92% of its revenue is clean.

Autodesk’s share price overcame a rocky earnings announcement in August to end 2019 strongly. In February 2020, it broke $200 for the first time.

Novozymes

The third Danish company on the list is Novozymes, a global biotech business. Novozymes produces microorganisms, biopharmaceuticals and industrial enzymes.

Novozymes’ sustainability credentials are impressive. It leapt from 68th in the Global 100 list in 2019 to sixth in 2020 thanks to its clean revenues and an impressive supplier score. MSCI has rated it at AAA for five years in a row. It also features in the FTSE4Good and Dow Jones Sustainability Indices and has been recognised by CDP as a leader in climate change and supply chain engagement.

ING Group

The majority of stocks on the Global 100 are in the financial services sector, and ING is the most sustainable of them all according to Corporate Knights. The Dutch multinational has a lower ratio of chief executive officer (CEO) to average worker pay than most financial companies, at just 21:1. It also pays comparatively more taxes, at 22%.

MSCI gives ING Group an ‘A’ rating but puts it in its ‘laggard’ category for financial product safety and system instability.

Enel

Enel is an Italian multinational energy company and the second-largest energy business in the world by revenue. It produces electricity primarily from geothermal, wind, solar and nuclear sources. This is its first year in the Global 100.

The company scores highly for its clean revenues, with over 80% of Enel’s total revenue classed as clean. It also performs well for energy and water productivity, areas that Corporate Knights considers key for the energy sector. MSCI rates the business as a leader in the fields of biodiversity and land use, renewable energy, water stress, carbon emissions and toxic waste.

Enel stock trades on the Borsa Italiana. It reached a new all-time high in February 2020.

Banco do Brasil

Banco do Brasil is Latin America’s largest bank and the oldest active bank in Brazil.

Corporate Knights ranks Banco do Brasil as one of the ten most sustainable companies in the world mostly thanks to how it treats its employees and the comparatively high rate of tax it pays (27%). Banco do Brasil’s CEO, Rubem Novaes, earns just 11 times what the average worker at the company does. Workers also get access to a healthy pension fund. Perhaps unsurprisingly, the company has a low employee turnover rate of a little over 2%.

Banco do Brasil is controlled by the Brazilian government, but its stock trades on the Sao Paulo Stock Exchange.

Algonquin Power & Utilities

Algonquin Power & Utilities is a renewable energy company based in Canada. It buys and operates hydroelectric, wind and solar power facilities, as well as sustainable utility businesses.

61% of Algonquin’s revenue is classed as clean by Corporate Knights. The agency also ranks its suppliers highly, with a score of 71%. MSCI, meanwhile, considers it a leader in the fields of corporate governance, biodiversity and human capital development.

Algonquin stock has performed steadily since early 2017, doubling from $11 to $22 at the beginning of 2020. The stock pays a dividend with a yield of 2.59%.

Osram Licht

The top German corporate on the list is Osram Licht, a lighting manufacturer that operates out of Munich.

The company scores highest for its social and governance practices. It has a robust pension fund for employees and 42% of its board is female.

Osram was spun off from manufacturing giant Siemens in 2013. A succession of profit warnings saw its stock plummet from €75 in January 2018 down below €25 in June 2019, but a protracted bidding war between AMS and Bain Capital helped it recover to €40 by the end of the year. It was successfully acquired by AMS in December.

Sekisui Chemical

Japan’s most sustainable company – and one of six Japanese firms on the Global 100 – is Sekisui Chemical. Sekisui Chemical is a plastics manufacturer based in Osaka and Tokyo, although it owns businesses in lots of other fields.

Sekisui scores well for how it treats its staff, with a turnover of just 1.5% and a low staff-injury rate. MSCI has ranked Sekisui as AAA for five years in a row, although it notes that it performs poorly in toxic emissions.

Sekisui stock gained around 16% in 2019.

Storebrand

Storebrand is a Norwegian financial services company, primarily engaged in insurance and pension investment. Founded in 1767, it is one of the oldest insurance companies in the world.

Women make up more than half of Storebrand’s board – well above the national quota of 40% – and its ratio of pay from its CEO to the average worker is just 6:1. That, plus a healthy pension fund for staff, secured Storebrand a place in the Global 100 for the first time in 2020.

Umicore

Umicore is a materials technology company based out of Belgium. It used to be primarily engaged in mining, but today focuses on refining precious metals and making specialised products from them. Umicore has been a component of the BEL20 for almost 30 years.

Corporate Knights ranks Umicore well due to its impressive waste productivity and high percentage of clean revenues. MSCI has given the stock a AAA rating, noting its positive practices in governance, waste, chemical safety and clean tech.

Umicore’s catalytic converter and recycling divisions beat expectations in 2019, but its shares dropped thanks to poor performance in its energy tech division.

Hewlett Packard Enterprise

Hewlett Packard Enterprise (HPE) is a US business-focused IT firm. It focuses on helping companies with servers, storage, networking and financial services. The business was formed in 2015 out of a split from the former Hewlett Packard Company.

Hewlett Packard Enterprise has strong female representation on its board, at over 40%, and low employee turnover. It keeps waste levels low and uses energy effectively.

Revenues at HPE slipped in 2019, down almost 6% from the previous year.

How to trade or invest in ESG stocks

  1. Do your research. IG Academy is a great place to start, with lessons on analysing stocks
  2. Open an IG account to trade or in invest in thousands of global shares
  3. Fund your account and buy your chosen companies

You can use your IG account to invest in ESG stocks with share dealing or trade on their price movements using CFDs or spread betting. With these, you can go long or short on ESG companies without taking ownership of any shares.

Not ready to commit any capital? Open a demo account to try out trading on all our available markets.

ESG investing outlook

KPMG estimated that a quarter of all professionally managed investments in 2017 were in ESG. It has only grown in importance in the years since, and there’s no sign that it is going anywhere.

Climate change dominated the headlines in early 2020, thanks in part to Australia’s raging bushfires. Divesting from fossil fuels is becoming standard practice – BlackRock’s CEO, Larry Fink, announced the firm would limit investment in coal in its active funds in 2019.

So the environmental side of ESG is likely to see strong growth in 2020 and beyond. Social and governance are likely to see progress as well, thanks to headlines such as Goldman Sachs tightening its diversity requirements for initial public offering (IPO) clients.

Take your position on ESG stocks with an IG account.


This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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