ESG: Investing sustainably in the HL Growth Fund

We’re embracing this within our workplace pension default fund, the HL Growth Fund, by integrating “ESG” factors into the investment process.

What is ESG?

It’s an investment approach where investors consider Environmental, Social and Governance factors as part of their wider research.

This can consider issues like:

Environmental, social and governance factors can play an important part in the long-term success of a company. For instance, a mining company might be less likely to face bad press if they have robust environmental and safety policies in place.

We believe that sustainable businesses have greater potential to offer sustainable returns to investors over the long term.

That’s why, six months on from the HL Growth Fund’s launch, Hargreaves Lansdown Fund Managers (HLFM) are making some enhancements to go even further in their approach. HLFM are our sister company which manages a range of funds including the HL Growth Fund.

What is the HL Growth Fund trying to achieve?

The fund aims to produce long term growth over rolling ten-year periods. It takes a relatively adventurous approach, investing around 80% of its value in the stock market. The rest of the fund’s assets are invested in bonds, which aim to provide diversification.

The managers of the HL Growth Fund form views on how much of the fund should be invested into each asset class (e.g. shares and bonds) and into which region (e.g. UK or North America). They won’t make frequent changes to these allocations, as their views are based on expectations of which areas offer the best potential returns over the long term, while also trying to avoid unnecessary risks along the way.

The fund invests into other funds, all but one of which are passively managed. The exception is for the High Yield Bond portion of the fund, which represents just 5% of the total assets. Passive investments aim to track the performance of an underlying stock market. For example, the managers target around 6% exposure to the UK stock market, which is mostly achieved through investment in the Legal & General Future World ESG UK Index. The managers expect this fund to perform in line with the broader UK stock market.

Although HLFM controls where the fund invests, they have appointed Legal & General Investment Management (LGIM) to construct the fund to our specification. LGIM has been managing tracker funds for more than three decades and they’re leaders in passive ESG investing, having won multiple awards for the ESG credentials of their products.

How is ESG integrated into the HL Growth Fund?

Our approach to integrating ESG varies in different parts of the fund, based on the availability of ESG-aligned investments in each area.

The fund is invested in LGIM’s ‘Future World’ fund range where possible. The funds within this range are launched with half the greenhouse gas intensity of their respective standard stock market indices. They also aim to decarbonise at an annual rate of 7%, targeting net zero by 2050.

Future World funds also have exclusions - certain things which they won’t invest in. These exclusions include:

The funds also exclude companies that consistently show a lack of awareness of climate change after engagement with the LGIM team.

Alongside these exclusions, the ‘Future World’ funds increase investments in companies that score well on a variety of ESG criteria – from the company’s impact on biodiversity, to the number of women on their board and the way the business treats its suppliers and employees.

They also reduce how much is invested in companies that don’t score as well on these measures – a process known as ‘tilting’. For example, Microsoft’s ESG score is relatively strong on all three factors and as a result HL Growth holds around one third more Microsoft shares compared to investing without an ESG tilt. On the other hand, the Fund has only around half the exposure to the oil giant Exxon Mobil compared to its normal weight on the stock market because the company scores poorly on environmental measures.

Where Future World funds are not available, the preference is to invest in alternative options which apply exclusions. Like the Future World Funds, these funds screen out companies involved in controversial weapons, coal miners and habitual UNGC violators.

Unlike the Future World funds though, they don’t screen out tobacco companies, and they don’t apply any positive or negative tilts. So investment in each company reflects that company’s normal size on the stock market.

If Future World and exclusions-based funds are unavailable, the managers will invest in more traditional index tracking funds (without exclusions or tilts).

Across the entire portfolio, including the non-ESG elements, LGIM use their position as a large institutional investor to vote on ESG issues at the annual meetings of companies in the portfolio. LGIM use engagement to encourage companies to move towards more responsible business practices.

It’s important to know that ESG investing is not the same as ethical investing. While ESG integration aims to mitigate or reduce exposure to the riskiest environmental, social and corporate governance practices, it does not completely exclude all companies in related sectors such as oil and gas. Ethical investing on the other hand is usually a term synonymous with entirely excluding investment in sectors deemed to be unethical.

Enhancing the HL Growth Fund’s ESG position

LGIM recently extended the range of Future World Funds, which means a greater selection of ESG tilted options are available to use in the HL Growth Fund. The managers are committed to enhancing the ESG integration in the Fund and have swapped some of the fund’s existing investments into Future World options to improve the overall approach to ESG integration.

Since the restructure in June, the percentage of the Fund invested with ESG tilts and exclusions is 85%.

ESG has been gaining popularity for several years and has become more mainstream. But it’s an area that’s developing quickly, and HLFM expect to make more enhancements to the approach over time.

Please note, this fund has a holding in Hargreaves Lansdown plc shares through the underlying funds. This is outside of HLFM’s control.