Blog – Why ESG-Focused Funds might be a Strong Investment Choice

Despite a history of greenwashing and historically dubious definitions of what defined an Environmental, Social, and Governance (ESG) qualifying investment, sustainable investing has now shifted from an ethical to a practical financial strategy.

Investors, emboldened by new, robust governance of what constitutes an ESG investment (from the International Capital Market Association (ICMA) and the International Regulatory Strategy Group (IRSG)), are increasingly focussed on firms which integrate ESG sustainable business practices that lead to long-term financial resilience. Beyond ethical considerations, ESG-focused funds offer key advantages: government-backed tax incentives, lower exposure to risk, and alignment with future economic trends.

The Performance of ESG vs. Traditional Funds

Historically, ESG funds had mixed financial returns compared to non-ESG investments. While some studies indicate that sustainability-focused funds outperformed during specific periods – particularly during economic downturns – others suggest they lagged in times of rapid economic expansion.

For instance, during the COVID-19 market downturn in 2020, many ESG funds showed greater resilience than their conventional counterparts. The MSCI World ESG Leaders Index outperformed the broader MSCI World Index by approximately 1.3% in that year, suggesting that companies with strong governance and sustainability practices were better equipped to handle economic shocks. Similarly, funds with high ESG scores saw lower volatility, reinforcing the argument that companies with strong ESG credentials may be less exposed to systemic risks.

However, in 2022, when energy prices soared due to geopolitical instability, ESG funds that avoided fossil fuel companies underperformed broader market indices, which were buoyed by oil and gas stocks. The S&P 500 ESG Index underperformed the S&P 500 by approximately 2.5%, reflecting the disadvantage of excluding high-yielding but environmentally unfriendly sectors during periods of energy-driven market growth.

It’s also been suggested that some highly rated ESG funds include companies that may not strictly adhere to sustainable practices. For example, major asset managers have faced criticism for including tech giants and multinational corporations with questionable labour practices or environmental track records in their ESG portfolios. This inconsistency has led some investors to question whether ESG funds truly reflect sustainable business models or are simply an exercise in “Green” marketing.

The Role of Government Incentives in ESG Investing

One undeniable factor in ESG’s financial appeal is government policy. The UK government, alongside other global financial regulators, introduced several tax incentives to encourage sustainable corporate behaviour. These include:

• Capital Allowances on Energy-Efficient Equipment – Allowing businesses to deduct 100% of the cost of green technology from taxable profits.
• Climate Change Levy (CCL) Exemptions – Providing tax reductions for businesses that meet energy efficiency targets.
• Landfill Tax Exemptions – Rewarding companies with sustainable waste management practices.

These incentives offer short-term financial advantages for ESG-conscious firms and, indirectly, their investors. However, tax benefits alone do not guarantee long-term profitability and the financial success of ESG investments still depends on broader market trends, sector performance, and global regulatory shifts.

Risk vs. Reward in ESG Investing

One of the strongest arguments in favour of ESG investing is risk mitigation. Companies that fail to meet sustainability benchmarks face increasing regulatory pressures, carbon taxes, and reputational risks. This has already impacted major industries: coal companies, for instance, have suffered valuation declines due to divestment by institutional investors. In contrast, businesses that align early with decarbonisation policies may benefit from government support, regulatory compliance, and investor confidence.

However, ESG-focused portfolios are not without their drawbacks. Some critics argue that ESG scoring models remain inconsistent, leading to subjective or even misleading ratings. Furthermore, investors in ESG funds may face higher fees, as ESG-focused funds often require additional research, compliance costs, and active management.

The Future of ESG Investing

The trajectory of ESG investing remains uncertain. While growing regulatory oversight and shifts in consumer preferences support its expansion, market performance remains a key factor in determining whether ESG strategies will deliver consistent long-term financial returns.

Ultimately, ESG investing presents a complex trade-off: it offers potential financial stability, reduced regulatory risk, and alignment with emerging economic trends, yet it also carries exposure to sectoral underperformance, regulatory inconsistencies and potential greenwashing. Investors must navigate these competing factors carefully, balancing ethical considerations with financial pragmatism when integrating ESG into their portfolios.

About the author:

Aryan Vedhara, a 15-year-old investor, podcaster and entrepreneur, studying at King’s College School, Wimbledon. His Podcast “Building Resilient Futures” helps young people / businesses navigate their future in a changing world shaped by AI, rapid / constant change, and demands for sustainability. Using the insights and experiences of leading entrepreneurs, CEOs and influencers from business, arts and media. He is also a co-founder of GreenerWorld – a bottom-up climate action movement created to inspire and mobilise individuals and organisations toward sustainable practices, to engage communities, advocate for impactful climate action, and drive innovation in sustainability.

This article reflects the opinions of its author and not necessarily those of ShareSoc.