Understanding environmental, social and governance (ESG) funds

What is an ESG fund?

An ESG fund is a fund that uses environmental, social and/or governance factors as its key investment focus and strategy. This means that ESG factors significantly influence the fund’s selection of companies to invest in.

The ESG factors used by an ESG fund and the way they are used differ across funds. Some examples of ESG factors include:

• Environmental – air and water pollution, greenhouse gas emissions, biodiversity, energy consumption;

• Social – labour standards, human rights, sustainable product sourcing; and

• Governance – shareholder rights, corporate culture and conduct, business ethics

What is ESG investing?

In ESG investing, funds incorporate ESG factors in their investment strategies or approaches in varying degrees as broadly set out below:

• Integration is where a fund considers ESG factors, alongside non-ESG factors such as company financial performance, in its decision to invest in each asset. This may include taking into account ESG risks in relation to climate change or corporate governance, which may become more material to financial performance over time

• Screening is where a fund seeks to either include assets that meet certain ESG criteria (known as inclusionary investing or positive screening) or exclude assets that do not meet certain ESG criteria (known as exclusionary investing or negative screening)

• Impact investing is where a fund seeks to achieve measurable ESG goals or outcomes (e.g. low carbon or renewable energy technology or solutions, sustainable infrastructure development or affordable housing)

Funds may also play an active role in shaping the ESG practices of companies that they invest in. For example, as a shareholder, a fund can influence a company’s actions by engaging with the board and senior management, as well as voting at general meetings.

What is greenwashing?

As an investor looking to invest in ESG funds, you should watch out for greenwashing, which is the risk that a fund may present itself as more ethical, sustainable or environmentally sound than it actually is, or has a greater positive impact on ESG outcomes than it actually does.

A fund may also present the sustainability targets of its underlying investments as more ambitious or aligned with legally binding international climate treaties or national commitments than they actually are.

An example of greenwashing is when a fund claims to achieve a certain level of ESG impact through its investment strategy without sufficient or credible evidence to support that claim.

Things to consider when investing in an ESG fund

As with any other financial products, you should think about the following before investing in an ESG fund:

• Your ESG investing goals – What are your ESG investing goals? To reduce carbon emissions or invest in companies with sustainable and/or ethical practices? How ‘green’ do you want the fund to be?

• The ESG fund’s investment strategy – Will the fund’s strategy meet your ESG investing goals? Will a fund that invests in companies providing solutions to specific environmental or social challenges meet your ESG investing goals?

What you should look out for as an investor

To ensure that adequate disclosures are made on the ESG aspects of a fund and mitigate risks of greenwashing, a fund that markets or represents itself as an ESG fund to retail investors must comply with MAS’ Disclosure and Reporting Guidelines for Retail ESG Funds (MAS Circular).

Under the MAS Circular, an ESG fund is one where ESG factors significantly influence the selection of investment assets. A fund that only uses negative screening or a fund that merely integrates ESG considerations into its investment process to seek financial returns would not qualify as an ESG fund under the MAS Circular.

In addition, ESG funds must disclose the following information in its prospectus and annual reports:

• the fact that the fund is an ESG fund under MAS Circular;

• the fund’s ESG investment focus and strategy;

• risks associated with the fund’s ESG investment focus and strategy;

• how the fund’s ESG investment focus is met and monitored;

• proportion of investment that meet the fund’s ESG investment focus;

• any action taken by the fund manager in achieving the fund’s ESG investment focus;

• sources of ESG data used