How to set up a portfolio based on the principles of ESG investing

ESG investing refers to any investment which abides by solid environmental, social and governance principles.
Investors may choose to focus on the ‘E’, the ‘S’ or the ‘G’ elements of ESG, or they may seek out a company which delivers on all three fronts. Where you place your focus is entirely up to you, but the first step in creating any ESG investment portfolio is setting your own expectations.

What does ESG mean to you?

There is no industry standard when it comes to defining ESG, which means that different companies can take markedly different approaches to their ESG credentials. The same is true for investors. Where one ESG investment portfolio may be focused on green energy and other environmentally friendly companies; another ESG-driven portfolio may focus on investing in companies which prioritise good governance, and have invested in a diverse and fairly-paid workforce.

When working out your personal definition of ESG investing, it may help to think of the ESG acronym as a formula, where a different weighting is attached to each letter. For instance, you may be 60% E, 30% S and 10% G. You can then apply this weighting to your ESG-led portfolio, choosing a majority of environmentally minded companies, alongside some companies which do a social good, and a minority of companies which may not be so strong on the E and the S but have excellent governance practices.

It is also possible to invest in ESG-themed funds and exchange traded funds (ETFs), where a selection of stocks and shares have already been chosen for you. If you are happy with the fund manager’s definition of ESG investing, this could be a cost-effective way of having a diversified ESG-led portfolio.

Due diligence

ESG investing is all about values, and to work out what a company’s values might be, you are going to have to do some due diligence. This involves:

• Checking out the company’s website and searching for key words such as ‘ESG’, ‘environment’ and ‘ethical’. Most companies will have a tab on company culture or an ‘about us’ page that includes some more information on their approach to environmental and social issues
• Googling the company and searching the news listings for any evidence of misconduct or employee issues. In the UK, you can also search Companies House to get a history of the firm’s financial performance. If the company has come close to being struck off the register due to late filings, or if their financial statements are incomplete or unaudited, this may indicate some governance issues
• Looking for specific targets that the company has set with regards to ESG. This may involve becoming carbon neutral by a particular year; planting a certain number of trees; or fundraising for local charities. If a company says they want to have raised £10m by 2024 for their local hospice, set a calendar alert for yourself for 1 December 2024, so that you can check in on this goal and decide whether or not you want to keep supporting that firm
• Reading the research that has been done by global financial analysis firms such Morgan Stanley Capital International (MSCI). There are several ESG ratings agencies and analytics firms which are dedicated to sifting through the real-world ESG performance of every listed company. They can be an invaluable benchmarking resource

How to set up an ESG investment portfolio

Once you know what you want out of your ESG investments, and you have chosen a selection of companies whose ESG credentials meet your expectations, you are ready to set up your portfolio.

Decide how much of your existing portfolio you want to convert into ESG investments, and then transfer your money into your new stocks, shares and funds.

Continue to track your portfolio’s ESG performance over time by reading any investment updates that arrive in your inbox and reading the financial press for early news of any trouble on the horizon. If you spot a new ESG opportunity, simply repeat the due diligence steps that you have already performed and rebalance your portfolio accordingly.

Take an active role

ESG investing is an ongoing pursuit, and your outlook will change as investment trends evolve and new ESG opportunities and crises emerge. But when your investments are driven by ESG principles, and you have taken an ESG-forward approach to your portfolio, you can take a more active role in how ESG investing develops.

As a shareholder, you have the right to attend annual general meetings and to submit questions to the executive management and board of the companies that you invest in. This is a great way to keep them accountable, and to remind them of the value of their ESG commitments.

You can take an even more active role in ESG-led investing by lobbying the regulators and the government of the day to make it easier to adopt ESG principles. Money speaks, and as an active investor with an ESG-led portfolio, you can have a powerful voice.