A guide to ESG investing

What is ESG investing?

ESG investing is a method of identifying stocks to buy based on Environmental, Social and Governance factors. These are non-financial factors that focus on a company’s behaviour and policies rather than its output.

The method is used by socially conscious investors to evaluate stocks that are both profitable and align with their beliefs about corporate behaviour within a company – such as attitudes toward gender and ethnic diversity – as well as the effect the company has on the wider environment, such as its carbon footprint.

As well as actively seeking out stocks that rank highly on ESG criteria, these investors will avoid companies that are engaged in risky or unethical practises. As such, there’s been a growth in mutual funds and brokerages creating products that screen for ESG factors.

 

What are ESG factors?

ESG factors are the criteria a firm would have to meet to be considered a sustainable company. Obviously, each investor or trader’s stance on what is considered ethical will vary but ESG factors act as an overarching set of rule guidelines for companies to follow.

There’s no hard and fast list of these criteria yet, but various bodies – such as the Sustainability Accounting Standards Board (SASB) – are working toward a standard across industries.

Currently, factors we know contribute to ESG investments include:

• Climate change and carbon emissions
• Air and water pollution
• Deforestation
• Energy efficiency
• Waste management
• Customer satisfaction
• Gender and diversity
• Employee Engagement
• Human rights
• Labour standards
• Anti-bribery and corruption
• Political contributions
• Whistleblower schemes

The main issue facing the ESG investing trend is ‘greenwashing’ – the tendency for brands to pretend their products and services are more compliant to ESG criteria than they actually are. Currently, there is no real measurement of ESG standards; it’s impossible to reliably enforce compliance.

It’s also important to screen your stocks by industry, as it is possible for morally dubious companies to score highly in ESG criteria. For example, a defence stock that produces weapons might score well in terms of diversity and inclusion, or waste management, but might not be an industry you want to invest in if you were antigun use.

 

Why is ESG investing a trend?

ESG investing is becoming a trend as the growing demand for change toward a more equal, eco-friendly and equitable society is taking centre stage.

These criteria are particularly important to the younger generations who often want to know that their investments aren’t going against their ethical views. Although it might seem a lot of these drastic changes are out of our control, by making more sustainable choices when it comes to the stocks we focus on, we can have a huge impact on the future of the planet, animals and our fellow humans.

In the last ten years alone, the trend toward sustainable investing has meant companies have to declare where their money goes, and what they’re going to use it for. Boards are constantly being held to account for their decisions regarding diversity and inclusion, and what measures they’re taking to reduce their companies’ carbon footprints. These changes didn’t happen overnight; they’re the result of individuals demanding change.

For example, NASDAQ is contemplating introducing rules that would require all listed companies to disclose their diversity commitments – particularly on their board of directors – as part of social standards. This was brought to the forefront by the Black Lives Matter movement, especially after the protests that erupted globally in 2020.

Companies are being forced to adopt the principles of ESG if they want to attract capital from younger generations and the more ethically minded investors. A study by the Chartered Financial Analyst (CFA) Institute showed that in 2020, 85% of its members considered ESG and that 65% of its clients demanded that they do so.¹

 

Why should I care about ESG investing?

Even if you’re not a socially conscious investor, ESG investing is still a trend worth taking note of as it will impact the profitability of companies over the long term, and impact the market’s perception of a stock. This could cause fluctuations should a company announce new ESG policies or go against existing ones.

According to accountancy firm Moore Global, businesses that express commitment to ESG have seen profits jump 9.1% over the past three years.

Plus, as ESG issues begin to be felt across the world – for example, climate change is causing flooding, demographic shifts and new government regulations – the impact will be felt in companies’ supply chains and production output.

Stakeholders, investors and traders are all putting pressure on companies to conform to ESG requirements. Companies that don’t make an effort to be more sustainable will likely not hold up in the longer term.

It’s unlikely that any company will be completely unaffected by the move toward ESG investing. This means that identifying ESG stocks will give you a chance to go long and short as the trend progresses – finding companies that will benefit from the sustainable drive and those that will fail because of it.

 

How to trade ESG companies

There are two main routes to trading ESG companies:

1. ESG stocks
2. The ESG index

What are ESG stocks?

ESG stocks are the shares of companies that are actively trying to conform to ESG requirements. So, it’s not just about the company’s products and services, it’s about their operations and internal policies – which need to safeguard the environment, employees, communities, and shareholders.

Most traders and investors will look at a stock’s performance history using ESG rating agencies such as MSCI and Sustainalytics.

Companies such as Nvidia, Microsoft, Adobe, and NextEra Energy consistently rank on a lot of ESG rating lists. However, alternative energies like First Solar and Orsted are also attracting ethical investment flows.

What is the ESG index?

The ESG index tracks the top 100 environmental, social and governance stocks listed in the US. It’s based on each company’s score using the Arabesque S-Ray scheme.

Trading the ESG index works in the same ways as any stock index, in that you’re getting exposure to group of shares from a single position. But instead of being from a single exchange – like the FTSE 100 for the London Stock Exchange or the Dow Jones for the US equity markets – the ESG index is for ethically sound company shares.

Securities that are involved in controversial businesses – such as weapons, defence, tobacco, alcohol, adult-entertainment, gambling, fossil fuels, and nuclear power – are excluded from inclusion.

The index is weighted according to the constituents’ ESG rating scores and rebalanced on a quarterly basis. There is a capping factor, which means no constituent can have a weight over 10% of the index.

What companies are on the ESG Index?

There are 100 companies on the ESG index, the top ten of which are:

1. Medpace Holdings
2. Deckers Outdoor
3. Ross Stores
4. Linde
5. Axcelis Techs
6. Applies Mats
7. Columbia Sportswear
8. Check Point Software Techs
9. Energizer Holdings
10. Air Products and Chemicals

 

Take your ESG position with City Index

When you trade with City Index you can take a position on ESG companies and the ESG Index using CFDs. You won’t take ownership of the underlying asset, which means you can take advantage of markets that are rising and falling in value.

Find your first opportunity using these easy steps:

1. Open a City Index account, or log in if you’re already a customer
2. Search for a company or the ESG index 
3. Choose your position and size, and your stop and limit levels
4. Place the trade

Or you can trade shares risk free by signing up for our demo trading account.

¹Chartered Financial Analyst (CFA) Institute, 2020