How to choose a sustainable fund or portfolio

In our Best Buy awards earlier this month, we presented our Best for Sustainable Investing award to honour those providers who are making some decent strides in trying to solve some of the biggest challenges in the world today (find out the winners of all of our awards here).

But, like many people, you’re probably wondering what a sustainable fund actually is?

The word ‘sustainable’ can be tricky to define in the world of investing, because it can mean different things depending on:

• Where you are (for example, definitions can vary from region to region)

• Where you get your information (different investment platforms can have different criteria)

• What type of companies you’re investing in (clean energy start-ups will probably have a very different concept of sustainability than big fossil fuel companies)

So, let’s start with the general definition...

The above can be linked to one acronym which is still relatively new to the block but has a lot of investors shaking their heads!

It's ESG

(read our guide here)

This stands for Environment, Social and Corporate Governance.

Sorry, what?

ESG is your bog standard corporate-financial jargon.

It’s a confusing term – both for investors and fund managers - but it’s basically a method for incorporating sustainability into your long-term financial returns. It’s widely used in the industry, so that means we’re stuck with it for now. But we’ll try and break it down into human terms below, to help you understand what to look out for in a fund that's labelled as 'sustainable/ESG'.

Give me the ‘E’!

This looks at the environmental footprint of the company and its suppliers.

1. Are they still tied to fossil fuels or making a big switch to renewable energy?

2. Has the company pledged to reach Net Zero (when its commercial activities as a whole will no longer contribute to greenhouse gas emissions)

3. Has it been a strong advocate for reducing carbon emissions?

Give me the 'S'!

This looks at the societal impact of the company and its suppliers.

1. Is the company linked to human rights abuses?

2. How does it give back to communities?

3. For example, has it donated money to charities that are helping to fund new schools and hospitals in developing countries?

Give me the ‘G’!

This looks at how the company is run.

1. What's the CEO's reputation?

2. Do employees get any seats at those board meetings?

3. What kind of reputation does the company have among its stakeholders?

So, I can just a pick a fund that’s labelled as ‘sustainable’ and ‘ESG’ and that's it?

Well, it's a good idea to use these ESG principles as a starting point for researching sustainable funds or portfolios. But in the absence of fancy regulations that could help you more easily discriminate a sustainable fund from an ‘unsustainable one’ – you may need to invest some time in research.

Part of the problem is that words like 'sustainability', 'green, 'socially responsible and 'ethical' can mean different things to different people. They are often used interchangeably under the ESG umbrella.

• But don't assume that 'sustainable' always means the same thing as 'ethical'.

• Or that 'socially responsible' is synonymous with 'green'.

It is difficult to get a clear answer.

But if all of the above is a bit confusing to you, here’s a summary of what to keep in mind while you research sustainable funds:

• What impact does the company have on the environment?

• What impact does the company have on communities?

• How does the company treat its employees, suppliers and customers?

Now it’s time to set your expectations

And accept that you may need to compromise, at least for now.

Because of the lack of standardised rules, sustainable funds are not created equally.

Some portfolios may look good on paper. But when you dig into the details, you may notice that some of those funds are still invested in fossil fuels. They may even own oil and gas companies but still carry the ESG label!

Beware of greenwashing

Many investors and fund managers are increasingly worried about 'greenwashing' – a term you may already be familiar with. To recap, this is when a company misleads people into believing that its funds or portfolios are more sustainable than they really are. We won’t get into that in too much detail in this blog, but we will be publishing a new article on this topic soon.

Greenwashing has spooked investment managers and sparked a lot of scepticism of ESG in general. Today, many fund managers are more concerned about the sustainability credentials than the projected returns, when recommending funds to their clients.

And that’s because more investors like you are demanding to see this information

What our research has shown:

So how do I choose a sustainable fund?

Firstly, you need to figure out what kind of sustainable investor you want to be

It’s hard to be a jack of all trades - and when it comes to sustainable investing, your money may be put to better use if you invest in something more specific.

What are your priorities?

If you're more concerned about community development, gender and diversity, achieving Net Zero, and other environmental issues, then consider opening an impact fund.

How does an impact fund work?

This aims to generate long-term financial returns while investing your money into a specific area, such as:

• Improving access to affordable healthcare in a developing country.

• Supporting conservation programmes in areas experiencing a significant loss of biodiversity.

• Improving global food security

But if you want to focus on the environment and sectors like renewable energy projects, you may want to choose an environmental sector fund.

How does an environmental sector fund work?

This is similar to impact investing. Your fund manager will aim to generate long-term financial returns while investing your money into a specific area, such as:

• Renewable energy projects like wind power, geothermal or solar energy

• Air pollution mitigation

• Improving waste management

Other social and governance factors to consider:

• Diversity and inclusion

• Anti-money-laundering

• Customer privacy

• Political lobbying

• Gender equality

The United Nations’ new sustainability framework is worth a look too

If you subscribe to our

, you may remember that we referred to the UN’s new 17 Sustainable Development Goals - which they’ve even broken down into – wait for it - 169 targets! Here they are again below:

This is a handful, to put it lightly! If you've got time to spare, you can read the full report here.

But, if like most people, you don’t have the time or the patience, maybe you can suggest a better way to present these categories?

How would you simplify this into 3 or 4 more-manageable categories? Which categories do you think should be measured and reported on? Let us know here.

This all very illuminating - but let’s cut to the chase:

Can I make money by investing in a sustainable fund?

Yes. Like with any fund or portfolios, returns are never guaranteed, and you may get back less than what you put in. But there’s plenty of reason to be optimistic about sustainable funds in the long term.

But didn’t ESG funds do badly in 2021?

Last year, we considered whether sustainable funds had run their course. After strong performance in 2020, returns fell in 2021, these funds sank to the bottom of the performance tables. But globally, sustainable funds still managed to attract record inflow (money in) during 2021.

But two years is a snapshot in the world of investing. Comparing performance in 2021 to the next 30 years is like comparing weather to climate.

Many fund managers are optimistic about the long-term growth prospects of the sustainable investment sector.

1. Morningstar data show that sustainable fund subscriptions rose to a record high of £37.1 billion in 2021.

2. Legally binding Net Zero targets will put more pressure on governments and businesses to divest from fossil fuels and switch to cleaner energies.

3. JP Morgan says it expects ESG investing to continue to grow in 2022 and beyond.

Time to compare your options?