Environmental, social, and governance (ESG) investing refers to standards that assist investors in making investments in businesses that take sustainability and ethical impact into account
It's worth taking a closer look at the industry and how it can support your investment strategy because there are a number of terms related to investments that place an equal emphasis on the environment and society as they do on financial performance.
Investors are increasingly taking into account the broader effects of their capital on society and the world rather than just long-term financial returns. Although they aren't always interchangeable, terms like sustainable, responsible, and ethical investing are frequently used to characterize this change.
The industry has undoubtedly been impacted by a perfect storm of economic and political factors. Demand increased between 2018 and 2022 as investment poured into sustainable strategies, regulatory support improved, and the Paris Agreement aligned global climate policies. In a survey conducted by the London Stock Exchange Group (LSEG), 86% of asset owners reported "evaluating or implementing" sustainable investing practices by 2022, up from 53% in 2018.
Conditions changed after that. In some markets, long-term sustainability goals have been overshadowed by inflation and economic uncertainty, while Russia's invasion of Ukraine increased energy prices and shifted focus to energy security and defense.
Watch the entire video here: At the same time, the cost of operating ESG funds has increased due to growing expenses and more complicated regulations. According to Julia Dreblow, founder of Fund EcoMarket and SRI Services, this has led to outflows along with shifting investor preferences that favor short-term trends and market cycles.
What does ESG represent?
Since the term was first used in the United Nations (UN) report Who Cares Wins in 2004, ESG has developed from a specialized idea to a common investment consideration.
Many investors now understand that the relationship between sustainable objectives and performance is more complex than what was once thought to be a trade-off between values and returns.
Businesses now prioritize corporate social responsibility (CSR), firmly integrating ESG factors into the investment environment and possibly fostering increased resilience against long-term risks such as climate change.
However, timeframes and sector dynamics play a major role in performance. Over the five years leading up to 2024, sustainable funds outperformed their traditional counterparts; however, in more recent times, many have fallen short due to higher interest rates and exclusions from industries like fossil fuels. However, opportunities in the energy and defense sectors might call for a more selective approach at the corporate level.
Robeco contends that although enthusiasm has subsided, investor sentiment has remained largely stable despite geopolitical pressure and shifting priorities around areas like cybersecurity and infrastructure, proving that ESG is not "dead," as some commentators have suggested.
What kinds of investments are covered by ESG?
It is a vast and intricate field with numerous definitions and variables.
E, or environmental element, examines the implications of businesses for sustainability and the climate. This covers resource usage, waste management, carbon footprints, and the move toward net zero.
The S social usually covers issues that impact local communities, workers, suppliers, and customers, among other stakeholders. Human rights, equitable pay, diversity, and working conditions can all fall under this category.
The G, or governance, encompasses executive compensation, board composition, accountability, transparency, and company leadership.
While there isn't a single method for applying ESG standards to a portfolio, most fund managers combine three different strategies.
Positive screening looks for companies that do well on ESG metrics or positively impact sustainability objectives, whereas negative screening excludes certain industries or businesses, such as tobacco, defense stocks, or fossil fuels.
Stewardship adopts a more proactive stance, with investors utilizing their power as shareholders to promote improved practices through voting, discussion, and tracking advancement toward goals. Advocates contend that without a seat at the table, it is difficult to influence a company.
By focusing on quantifiable social or environmental results in addition to financial gains, impact investing goes one step further. Examples of such projects include renewable energy initiatives or companies that tackle social issues.
ESG extends beyond stocks. Fixed income also has an impact, usually through ethical or green bonds that finance companies or projects that satisfy specific sustainability standards.
How to put money into sustainable or ESG funds.
There are various ways for investors to make sustainable or ESG investments.
If you're interested in direct shares, it might be worthwhile to check how certain companies are ranked using an independent research tool like Sustainalytics from Morningstar or MSCI ESG Ratings.
Think about your screening criteria in the context of the aforementioned impact or negative or positive screens, for instance. Compare this to each company's individual ESG or sustainability report, which can be found in the investor relations section of business websites and is frequently published alongside or mentioned in the annual report. On the trading platform of your choice, you might also find more information about ESG.
Examine model portfolios and funds that incorporate ESG factors (sustainable options are frequently offered alongside platforms' main ranges).
Janus Henderson UK Responsible Income Fund, which has an ongoing charge figure (OCF) of 0.85 percent, is one actively managed equity income component of Hargreaves Lansdowns Wealth Shortlist.
Some choices for actively managed bond funds are Royal London Ethical Bond, Aegon Ethical Corporate Bond, Rathbone Ethical Bond, and Columbia Threadneedle UK Social Bond.
Although each will concentrate its support in a different way, these usually support specific local or national government initiatives, businesses, or projects.
Legal & General offers a number of passive funds with varying regional tilts, including Legal & General Future World ESG Tilted & Optimized UK, World, and Emerging Markets portfolios. Each tracks its own Solactive L&G Enhanced ESG Index and integrates exclusions, stewardship, and ESG integration.
The Vanguard ESG Developed World All Cap Equity Index Fund is a broader index fund, while the Wisdom Tree Renewable Energy UCITS ETF and the Invesco Hydrogen Economy UCITS ETF are two more focused, thematic ETFs. One well-known tracker for fixed income is iShares ESG Screened Overseas Corporate Bond.
In other places, government-backed options such as National Savings and Investments (NS&I) offer fixed-rate green savings bonds that let you lend money to the government to finance environmentally friendly projects like zero-emission buses or wind power.
In what ways have ESG funds performed?
One of the most contentious issues in ESG investing is still performance. Morningstar reports that global sustainable funds saw net outflows of about £27 billion in the fourth quarter of 2025, after outflows of almost £55 billion in the preceding quarter."substantial" portion of these outflows were attributed to large UK institutional clients.
However, Morningstar noted that the transfer of funds from pooled ESG funds to custom mandates did not necessarily indicate a decline in interest.
And returns have been inconsistent. ESG-focused stocks have recently underperformed the overall market using UK indices as a proxy. According to Morningstar, the UK Target Market Exposure index returned 78.2 percent over a five-year period, while the UK Sustainability index returned 32.2 percent.
However, fund flows and short-term performance don't always convey the whole picture. Given that ESG funds are frequently concentrated in particular industries or styles, broader trends in asset allocation frequently have a big influence.
According to Dreblow, investors are still worried about climate and environmental issues, but ESG strategies are disproportionately impacted by broader market changes.
"People aren't necessarily rejecting sustainability because of this. People oppose rising sea levels, widespread fires, and other extreme weather phenomena. Individuals are concerned. However, it will matter if there is a move away from the UK and away from stocks," she stated.
"These things swing, and they'll swing back."
How do regulators feel about ESG?
The Financial Conduct Authority (FCA) implemented Sustainability Disclosure Requirements (SDR) in recent years to address concerns about greenwashingthe practice of making ESG-related claims that cannot be verifiedand to help consumers better understand and compare ESG investments.
According to Dreblow, SDR was well-meaning but difficult to implement in practice. He claimed that many managers found it challenging to comply with the level of granularity required around fund labels, particularly when portfolios fluctuate over time.
The FCA has also held consultations regarding its future strategy for regulating ESG ratings; results are anticipated later this year, and a new ESG rating system is scheduled to take effect in 2028.
According to Dreblow, many rating agencies had limited access to environmental and social data during the surge in sustainable investing a few years ago. As a result, assessments were skewed toward the G because governance intelligence was easier to obtain because of earlier laws.
ESG's origins go much deeper. The origins of ethical investing can be found in religious movements that shunned "sin" stocks associated with gambling, alcohol, or weapons.
The first ethical fund in the UK was introduced by Friends Provident in 1984, giving investors the first clear chance to match their financial goals with their moral principles.
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