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Ethical and ESG Investing is getting harder

The recent annual trading announcements from BP and Shell have highlighted why ethical or ESG focused investing is becoming a harder choice for investors. Record annual profits from both organisations have led to a boost in their share values and greater dividends for shareholders. When you’re trying to pull together a mixed portfolio of investments, this kind of trading performance is hard to ignore, especially when other organisations with an ethical remit are beginning to struggle due to economic conditions.

The trading statements also contained within them updates on their environmental ambitions, the detail of which may cause further concern to anyone wanting a high performing yet ethically focused portfolio. In particular, BP has said it is revising its commitment to drop fossil fuels, lowering its reduction targets and pushing the overall phasing out deadline further into the future. This will not sit well with anyone for whom environmental impact is a key decision when selecting investments. But balancing this off with the attractive returns on offer is a tough choice when considered in the wider economic context.

What is ESG or Ethical investing?

Ethical or ESG (Environmental, Social and Governance) investing is where the focus of the investment is on the moral compass of the company. Ethical companies may be those creating renewable energy schemes, developing products that address long standing environmental issues e.g., removing products from landfill or providing support to segments of society most in need. ESG investments look slightly wider and can encompass bigger, household names. In these cases, the microscope looks at how the business is run, what is does to help society and how it is trying to reduce its environmental impact. Each aspect of the company’s structure and operations is looked at and scored – so for instance staff share schemes or employee representation at the board level could earn points for positive social and governance impact. The company then receives an overall assessment which is RAG (red, amber, green) rated. Those with the most positive impact being classed as dark green. In the same way as traditional investments focus on the level of risk, ethical investors may want to be majority green.

Difficult trading conditions

Away from the giants of the global economy, trading conditions generally are tough and far from ripe for new, innovative start-ups. Fund managers are therefore having to be careful where they place their money as the risk associated with ethical companies increases. There’s less institutional start-up capital and seed funding as platforms choose to move their cash into those safe and high performing operators like BP and Shell.

During the last couple of years, the spotlight has fallen on what ESG actually means and a number of companies that were previously deemed to be ‘dark green’ i.e. extremely positive from an ethical/ESG perspective, are not as strong as first imagined.  Simply having a good environmental policy is extremely different to putting environmental, social and governance (the E, S and G) at the heart of every decision they make. Some businesses have been exposed as not really meeting any of their own goals whilst others have moved into more of a ‘light green’ rating – leaving investors with serious concerns.

For the last decade, ethical investment opportunities have rewarded the risk factor with the potential of significantly higher returns than can be achieved elsewhere. Renewable energy schemes offering up to 6% are not unheard of and until recently that would have looked extremely attractive – even with investments being tied up for up to 15 years, no security and returns based on your original investment, not compound growth. But with interest rates rising and savings linked current accounts now paying between 4% and 5% for cash deposits, and all the security that offers, it feels as though you’ve got to be a hardened ethical investor to persevere.