ESG investing: Why it’s important to balance risk

Two children walking through a bluebell wood.

It’s a common misconception that considering ESG (environmental, social, and governance) factors when making investment decisions could be riskier and involve more volatility. Research suggests that’s not the case, but balancing risk with your goals in mind is still important. 

When incorporating ESG issues into your investment strategy you might include assessing how a business manages its supply chain and human rights issues, or whether a fund invests in fossil fuel companies.

If ESG factors are a part of your investments, you might avoid investing in certain businesses or allocate a proportion of your portfolio to firms that are solving particular challenges. 

So, you could be excluding or including some businesses based on their practices. Some believe this approach might lead to more risk and volatility. However, the opposite could be true.

Green bonds and investments may experience less volatility 

A huge number of factors affect the value of investments. So, it’s normal for values to rise and fall. 

Speaking to FTAdviser, Sascha Stallberg, a green bond fund manager, said: “Looking at the technical picture, several studies have shown that the historical volatility of green bonds is slightly lower than conventional bonds.” 

He added: “Even for investors not interested in ESG, there is not a strong argument against investing in green, social, and sustainability bonds.” 

Research paints a similar picture when it comes to stocks and shares too. A 2021 study found that an ESG portfolio was “relatively less turbulent” when compared to a market benchmark.

One of the reasons why ESG investments may be less volatile is that businesses might consider some of the long-term challenges that could affect operations. For instance, a firm that has reduced its reliance on fossil fuels may be more secure if oil prices rise or the government pledges to cut non-renewable energy use. 

While research indicates ESG investments could be more stable, that doesn’t mean all opportunities that consider ESG factors are right for you. Assessing the risk profile of investments is still an important task.  

3 helpful questions to consider when you’re weighing up ESG investments 

1. How does the investment align with your risk profile?

If you find an investment that aligns with your ESG criteria, it can be tempting to seize the opportunity. However, it isn’t necessarily right for you from a risk perspective.

Your risk profile can help you select investments that are appropriate for you. When setting out your risk profile, you might consider things like the reason you’re investing and how comfortable you are with investment risk. 

Assessing an opportunity against your risk profile may help you make decisions that are right for your goals. If you’d like help creating your risk profile or determining whether you should invest in a particular company or fund, please contact us. 

2. Do you plan to hold the investment over the long term?

While the research suggests ESG investments may experience less volatility, that doesn’t mean the value of an investment won’t rise and fall. It’s often a part of investing and something you should expect.

Due to volatility, it’s usually a good idea to invest with a long time frame in mind.

If you invest for a short period, you may find the market has dipped when you want to sell the asset, so the value of your investment has fallen. Holding an investment over the long term may provide an opportunity for the peaks and troughs to smooth out, so there’s less chance of the value of your investment falling.

So, your investment time frame is often an important part of understanding potential risk and what’s appropriate for you. 

3. Does the investment complement other assets you hold?

When you’re investing, you want to create a balanced portfolio. That could mean including investments from different industries and geographical locations as well as balancing different levels of risk.

A balanced portfolio could help reduce volatility – when some investments fall in value, others may rise.

Whether ESG is part of your investment strategy or not, understanding how an opportunity fits into your wider portfolio is important. 

You might also want to consider other assets you have outside of an investment portfolio when balancing risk. For instance, you may want to include how much cash you have in a savings account or property when weighing up an opportunity. 

Contact us to talk about your investment strategy

Tailoring your investment strategy to suit you could help your portfolio accurately reflect your risk profile. We can help you create a strategy that suits your needs, including if you’d like to consider ESG factors when making decisions.

Please contact us to talk about your investments and how they could help you reach your goals.  

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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