Holly Black: Welcome to Morningstar's 'Ask the Expert'. I'm Holly Black. With me in the studio today is Dan Kemp. He is Chief Investment Officer at Morningstar Investment Management.
Hello.
Dan Kemp: Hello, Holly.
Black: So today we're here to talk about ESG, quite a buzz word in investment at the moment. What does it mean?
Kemp: Okay. So that's a really big question. The simple answer is that ESG is an acronym and it means environmental, social and governance, and those are the three areas that investors look for when thinking about how sustainable a company is. So, are they doing things which will damage the environment? Are they doing things that damages society? Or are they running companies with poor governance which could ultimately lead to damaging that company's prospects in the long term. And so really it's just a way of highlighting more sustainable companies and directing investment ultimately towards those more sustainable companies.
Black: But I'm an investor I just want to put my money in the fund and see it grow, why should I care?
Kemp: Well that's a really good question and it stems from the fact that when you're investing in a fund, when you're saving for retirement then typically you become an owner, a part-owner of lots of different companies, and of course as an owner people feel responsible for how their money is invested and what it is that they own. So, in the same way that people will choose to recycle, will pick up their litter, will want to make sure that they are donating to charities that are aligned to their views of the world, then often people want to make sure their portfolios have aligned to those views as well. So, many people feel uncomfortable owning a company, part-owning a company that pollutes a great deal, much more than normal or that uses sweat shops for example or has unethical practices or poor governance. And so ESG is simply a way of integrating your world view with your investment portfolio.
Black: One of the things that stops people from investing in ESG and sustainable and ethical funds, is there is this sort of feeling that if you are ruling out certain companies then you are limiting your potential investment returns. Is that true?
Kemp: Well, it’s a really good point for people to think through and the first thing to say is that ESG covers a very broad range of investment types and ways of investing. And so in some cases you are right that ESG fund could exclude a whole range of possible investments leading to a very narrow subset of the overall investment universe that people can invest in and that could result in people excluding companies with good prospects. There are other forms of ESG which are really focused around simply investing in the best companies from a sustainability point of view in each sector, rather than exclusion. And a third strand where investors are simply looking to engage with those companies and improve what they are doing rather than use ESG as a selection criteria.
So there is a whole range of possible opportunities for investors and it's really important that either they do the work to understand how they are investing which is relevant to them or that they are using a financial advisor that’s an expert in that area that can help them. But in reality we have to remember that for most ESG strategies the companies that you'll invest in are a subset of the overall investment universe in some way. So if that subset comprises the most expensive stocks which could happen then yes it could affect returns equally it's entirely possible that an ESG index could do better than a conventional index simply because of the way that it's weighted. So the key thing for investors is to really understand what is that they are buying what they are excluding and how that could impact their portfolio over the long term.
Black: Dan thanks so much for your time. And thanks for joining us.
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