What Is ESG Investing?
ESG investing incorporates environmental, social, and governance factors into investment analysis and portfolio construction. It has grown from a niche interest of specialist ethical funds to a mainstream consideration embedded in the portfolios of major institutional investors worldwide.
The growth reflects two distinct motivations:
Values-based motivation: Investors who wish their portfolio to align with their personal values — by excluding companies involved in fossil fuels, weapons, tobacco, or human rights violations, or by actively selecting companies with strong social and environmental practices.
Financial motivation: A growing body of research and institutional practice holds that companies with strong ESG characteristics face lower long-run risks (regulatory, reputational, operational) and may be better positioned for long-term value creation. From this perspective, ESG analysis is an input into risk-adjusted return estimation rather than a purely values exercise.
For internationally mobile investors, ESG is implemented through the same vehicles as conventional investing — UCITS ETFs, SICAV funds, and direct equity selection — but with additional layers of data and selection criteria.
ESG Ratings: What They Measure and Their Limitations
ESG ratings are produced by specialist agencies (MSCI, Sustainalytics, ISS, Bloomberg, S&P's Trucost) using a combination of company disclosures and modelled data. Ratings are expressed as scores (MSCI uses AAA to CCC; Sustainalytics uses 0–100), and are used by fund managers to screen or weight portfolio holdings.
What ESG ratings measure: Each agency applies its own methodology, weighting the three pillars (E, S, G) differently, using different data sources, and focusing on different aspects within each pillar. MSCI's ratings focus primarily on material risks and opportunities from ESG factors relative to industry peers. Sustainalytics focuses on unmanaged ESG risk exposure. This methodological diversity means a company can receive very different scores from different agencies.
Low inter-rater correlation: A study published in the Review of Finance (2022) found correlations between ESG ratings from different agencies of approximately 0.5 — significantly lower than the near-perfect correlation of credit ratings from different agencies for the same bond issuer. This is not primarily because the agencies are wrong, but because they are measuring different things under the same "ESG" label.
Implications for investors: The choice of ESG data provider significantly affects which companies are included or excluded from an ESG portfolio. Relying on a single rating agency's scores introduces a methodological bet that investors may not intend.
Greenwashing risk: The self-reported nature of much ESG data (companies disclosing what they choose to disclose) creates scope for misrepresentation. Rating agencies attempt to supplement disclosed data with estimated figures, but material gaps remain. Investors in ESG funds should periodically review the actual holdings of funds to verify that the portfolio reflects stated ESG principles.
ESG Product Types
ESG index ETFs: The most accessible entry point for retail and HNW investors. Examples include:
- iShares MSCI World ESG Screened UCITS ETF: Screens out tobacco, controversial weapons, thermal coal, and companies with severe ESG controversies. TER: 0.20%.
- Vanguard ESG Global All Cap UCITS ETF: Broader ESG screening across developed and emerging markets. TER: 0.24%.
- MSCI ESG Leaders ETFs: Select the top 50% of companies by ESG score within each sector. Maintain broad sector diversification.
- FTSE4Good: FTSE-designed ESG index, used by several ETF providers.
ESG active funds: Active managers applying ESG analysis as part of stock selection. The breadth of ESG integration varies — from funds where ESG is a primary screen to those where it is one input among many. Costs are typically higher than passive ESG ETFs.
Exclusions vs best-in-class: ESG strategies differ in their approach:
- Negative screening (exclusions): Eliminating specific sectors or companies (tobacco, weapons, fossil fuels, gambling). Clear and transparent.
- Best-in-class: Investing in the best ESG performers within each sector, including energy companies with relatively good ESG scores. Maintains broad sector diversification but includes industries that some investors wish to avoid entirely.
- Thematic: Investing in specific themes (clean energy, water, sustainable agriculture) regardless of their ESG score classification.
EU SFDR Classification: Under the EU's Sustainable Finance Disclosure Regulation (SFDR), funds distributed in the EU are classified as:
- Article 6: No specific sustainability claims
- Article 8: Promotes environmental or social characteristics
- Article 9: Has sustainable investment as its objective
Article 9 funds (the most stringent category) have faced greater regulatory scrutiny — several large fund managers downgraded funds from Article 9 to Article 8 after stricter guidance emerged, reflecting the higher evidential bar required. International investors in non-EU jurisdictions are not subject to SFDR themselves, but many funds they access will be SFDR-classified.
ESG and Performance: The Evidence
The performance history of ESG strategies is contested, and reasonable observers disagree about the conclusions.
2010–2021 period: ESG indices modestly outperformed conventional equivalents over this period. The primary driver was factor exposure: ESG screens tend to underweight energy (a poor performer for most of this period) and overweight technology and quality-oriented companies (strong performers). Whether this reflects genuine ESG "alpha" or simply factor tilts (quality, low volatility) that happen to correlate with ESG scores is debated.
2022 onwards: Rising energy prices and the Ukraine war triggered sharp outperformance by energy companies. ESG indices with significant underweight in fossil fuels underperformed conventional benchmarks markedly in 2022. This illustrates the sector concentration risk in exclusion-based ESG strategies.
Long-run evidence: Academic meta-analyses (including a widely cited review of more than 2,000 studies by Friede, Busch, and Bassen, 2015) find a positive relationship between corporate ESG characteristics and financial performance in the majority of studies. However, the magnitude is modest and the research is subject to publication bias (positive findings are more likely to be published). The most defensible conclusion is that ESG investing does not systematically destroy returns, and may provide modest risk-reduction benefit over time — rather than that ESG is a reliable source of outperformance.
Investors who pursue ESG primarily for values reasons are not making a financial sacrifice, on the balance of evidence. Investors who pursue ESG expecting systematic outperformance may be disappointed.
Implementing an ESG Tilt in an International Portfolio
For international investors wishing to incorporate ESG considerations in their portfolio:
Step 1: Define your ESG priorities. Is this primarily about values (exclusions), risk management (avoiding companies with poor governance), or alignment with specific themes (climate)? Different motivations lead to different implementation choices.
Step 2: Choose the right ESG approach. Negative screening (clear exclusions, simple to understand) versus best-in-class (maintains diversification, but includes industries you may object to) versus thematic (high conviction, concentrated).
Step 3: Select appropriate instruments. UCITS ESG ETFs cover most major exposures at low cost. For thematic or impact investing, specialist funds may be required.
Step 4: Review actual holdings. The ESG label on a fund does not guarantee its portfolio aligns with your values. Verify the top holdings and the exclusion/inclusion criteria.
Step 5: Accept the tracking difference. An ESG portfolio will perform differently from a conventional market-cap index — sometimes better, sometimes worse, depending on factor exposures and sector movements. If tracking the broad market index closely is important, ESG tilts create unavoidable divergence.
Step 6: Monitor. ESG scores and company behaviour change. An annual review of the fund's methodology and major holdings is appropriate.
This guide is for general information only and does not constitute regulated investment advice. The value of investments can fall as well as rise and you may get back less than you invest. ESG criteria and ratings methodologies are not standardised and may change. Past performance is not a guide to future returns. Tax treatment depends on individual circumstances and the laws of multiple jurisdictions, which may change. Always seek independent regulated advice before making investment decisions.
How Global Investments can help
Global Investments helps internationally mobile investors incorporate ESG principles into their portfolios in ways that reflect their specific values and financial objectives. We provide independent assessment of ESG fund methodology, help clients identify genuine ESG products rather than greenwashed alternatives, and integrate ESG considerations into overall portfolio construction. Contact us to discuss sustainable investing.
Frequently Asked Questions
What does ESG stand for and what does each component measure?
ESG stands for Environmental, Social, and Governance. Environmental factors cover a company's carbon emissions, resource use, waste management, and climate risk exposure. Social factors cover labour practices, supply chain standards, diversity and inclusion, data privacy, and community relations. Governance factors cover board structure, executive remuneration, shareholder rights, transparency, and anti-corruption measures. ESG scores are produced by rating agencies (MSCI, Sustainalytics, ISS, Bloomberg) using company-disclosed and modelled data.
Is greenwashing a real risk in ESG investment products?
Yes, greenwashing — misrepresenting the environmental or social credentials of an investment product — is a significant issue in the ESG market. The absence of a single global ESG standard means fund managers can apply inconsistent definitions of 'sustainable' or 'responsible' investing. EU regulation (SFDR) has introduced a classification system (Articles 6, 8, and 9) that imposes disclosure requirements, but the classifications are self-reported. Investors should scrutinise fund holdings, methodology, and exclusion lists rather than relying solely on ESG labels.
Has ESG investing delivered better or worse returns than conventional investing?
The evidence is mixed and depends heavily on the period examined and the specific benchmark comparison. ESG indices modestly outperformed conventional equivalents over the 2010–2021 period, largely because ESG indices were underweight energy (which performed poorly) and overweight technology. Since 2022, with the energy price spike and tech correction, many ESG indices have underperformed conventional benchmarks. Long-run evidence suggests ESG tilts have no consistent systematic return advantage or disadvantage relative to the market, after adjusting for factor exposures.
What is impact investing and how does it differ from ESG?
ESG investing typically applies ESG screening or tilting to otherwise conventional investment portfolios — it may exclude the worst companies or overweight the best by ESG scores, but is primarily a financial strategy with ESG considerations overlaid. Impact investing specifically targets investments that generate measurable positive social or environmental outcomes alongside financial returns, often in areas such as affordable housing, clean energy, financial inclusion, or healthcare access. Impact investing is typically in private markets (social impact bonds, development finance, green infrastructure); listed impact investing is less common and harder to verify.
Is ESG investing available in the same jurisdictions as conventional investing?
Yes — ESG ETFs and funds are available through the same platforms and custodians that offer conventional investments. UCITS ESG ETFs are accessible to international investors in the same way as conventional UCITS ETFs. Some thematic impact funds are available only through private channels or require professional investor status. ESG considerations do not limit platform access.
This guide is for general information only and does not constitute financial advice or a personal recommendation. The value of investments can fall as well as rise and you may get back less than you invest. Past performance is not a guide to future returns. Tax rules, investment regulations, and the availability of specific investment vehicles change — always verify current rules and seek advice from a qualified independent financial adviser before making any investment decisions.