With the COP26 summit drawing to a close, climate change is likely to linger in conversation for a long time to come. As an investor, I can look to pick stocks that are friendly towards the environment. When I also add in companies with appropriate governance and good social actions, it evolves into ESG investing. Some are concerned that ESG investing can sacrifice potential profits, but I’m less convinced.
Larger focus gives more choice
One reason why ESG investing isn’t restrictive is due to the evolution of the area over time. A decade ago, I’d agree that I could struggle to pick a diversified and rewarding portfolio that ticks all my boxes. However, in recent years a lot more companies have stepped up and made commitments to the cause. This includes things such as reducing emissions, being net carbon neutral, establishing fair pay and having more diversity in senior positions.
As a result, I no longer have to reduce my watchlist down to so few stocks that my returns are hampered. The fact that I have a lot of choice also means that I can cast aside companies that aren’t performing well financially and still have options for investing my money.
Negative ESG stock screening
Another point that’s worth mentioning is that my criteria for selecting ESG stocks can be looked at in two different ways. I can aim to pick stocks that are outright ESG-friendly. Alternatively, I can simply screen out ‘negative ESG’ companies. These would include high polluters or violators of environmental standards.
If I use the second approach, it would give me a lot more choice. Yes, the two approaches may sound broadly similar, but only screening out negative companies leaves me with companies that might not be ESG pioneers, yet are still worthy of inclusion.
I think this method could be worthwhile as it leaves the door open for me to benefit from companies flipping to making new pledges in years to come. If I buy a stock now that decides to push towards ESG goals next year, I could see an uplift in the share price because of this.
Achieving both aims is possible
The final point regarding ESG investing is that both my goals aren’t mutually exclusive. What I mean by this is that just because a stock is seeing high growth, doesn’t mean that it can’t be ESG-friendly.
For example, over the past year, the FTSE 100 index has returned around 30%. During the period, this benchmark return has been exceeded by stocks that I think are ESG-friendly. These include examples such as Royal Mail, Compass Group and Aviva.
One risk I need to be aware of is that ESG stocks could be seen as more sensitive to reputational damage. If environmental goals aren’t met or if negative reports surface in this regard, then it can see the share price take a large hit.