What are ESG funds and are they worth investing in?
ESG (environmental, social and governance) funds invest using environmental, social and governance criteria alongside financial ones.
Financial information only
This article is for informational and educational purposes only. It does not constitute financial advice, a recommendation to buy or sell any investment, or a personal investment recommendation. All investments carry risk and you may get back less than you invest. Past performance is not a reliable indicator of future results. Please consult a qualified financial adviser who is authorised by the FCA (Financial Conduct Authority) before making any investment decision.
ESG (environmental, social and governance) funds invest using environmental, social and governance criteria alongside financial ones. They are a large part of the sustainable investing market, but also one of the most debated. This guide explains how they work, what the performance evidence actually shows, and what to watch for before putting money in.
What is an ESG fund?
An ESG fund is an investment fund, typically a unit trust, OEIC (open-ended investment company) or exchange-traded fund, that selects or weights its holdings based on environmental, social and governance factors alongside standard financial criteria. The underlying theory is that companies with stronger ESG characteristics may face fewer risks, be better managed or be better positioned for the long term. Whether that translates into better investor returns depends on the fund, fees, market cycle and methodology.
The category is extremely broad. "ESG fund" covers everything from a mainstream index fund that excludes a handful of sectors (weapons, tobacco) to a deep-impact fund that actively invests in renewable energy infrastructure. The label alone tells you very little about what a fund actually does.
How ESG funds select holdings
ESG funds use different approaches to build their portfolios. The main strategies are:
Exclusion screening - removing companies in specific sectors such as fossil fuels, weapons, tobacco or gambling. This is the most common and least demanding approach. Many funds that label themselves ESG use only negative screening.
ESG integration - incorporating ESG ratings data into the investment process alongside financial analysis. This is standard practice at many large asset managers, whether or not the fund is labelled ESG.
Positive screening / best-in-class - selecting the highest ESG-rated companies within each sector, even if that includes oil companies with relatively good environmental practices compared with peers. Best-in-class funds remain diversified across sectors.
Thematic investing - concentrating on specific ESG themes such as clean energy, water, sustainable agriculture or gender diversity. These are often more concentrated and sector-specific.
Impact investing - investing specifically to generate measurable positive environmental or social outcomes alongside financial returns. True impact funds are more demanding and typically less liquid.
Does ESG investing perform?
The honest answer is: it depends on the time period and the methodology.
| Period | ESG vs benchmark performance | Key driver |
|---|---|---|
| 2019-2021 | Significant outperformance | Tech overweight, fossil fuel underweight benefited from growth environment |
| 2022 | Significant underperformance | Energy price spike; fossil fuels outperformed; defence exclusions cost returns |
| 2023-2025 | Roughly in line | Normalisation; varies significantly by fund and sector |
The structural argument for ESG is that better-governed, lower-risk companies may outperform over the long run. The evidence remains contested. What is clearer is that ESG funds reflect specific portfolio tilts, such as sector weights and factor exposures, that will help or hurt depending on market conditions. They should be evaluated on actual composition, fees and methodology, not just the ESG label.
Greenwashing red flags
The ESG fund market has a significant greenwashing problem. Funds with "sustainable," "responsible," or "ESG" in their name may still hold substantial positions in oil and gas companies, airlines, or arms manufacturers, depending on how their methodology is constructed.
Red flags to watch for:
- Vague methodology disclosure, with no clear explanation of how ESG criteria are applied
- Weak sustainability classification or unclear labelling, especially where the fund has no explicit sustainability objective
- High overlap with the standard index, where the ESG label adds little real difference
- No clear holdings disclosure, stewardship policy or explanation of exclusions
The EU's SFDR (Sustainable Finance Disclosure Regulation) classifies funds into three tiers: Article 6 (basic ESG disclosure), Article 8 (promotes environmental or social characteristics), and Article 9 (has sustainable investment as its objective). Article 8 and 9 funds are held to higher disclosure standards than Article 6.
What to look at before investing
If you are researching an ESG fund:
- Read the Key Investor Information Document (KIID) and fund factsheet
- Check the actual top 10 holdings. Do they match the fund's stated objectives?
- Note the SFDR classification (Article 6/8/9)
- Compare the ongoing charges figure (OCF) against non-ESG equivalents
- Check the ESG methodology document if published
For more guidance on sustainable funds, exclusions and UK labelling, use the sustainable funds guide. If your priority is fossil fuel exposure specifically, compare this article with our guide to fossil-free funds in the UK. For a real-world example of a large public investor using explicit exclusions, read our guide to Norway's sovereign wealth fund.
How to compare two ESG funds
Use the same comparison frame for every fund: objective, benchmark, holdings, exclusions, fees, stewardship and reporting. If one fund is cheaper but has weaker disclosure, the decision is not automatically obvious. If another fund has a stronger sustainability claim but a narrow sector mix, it may behave very differently from a broad market fund.
The most useful question is not "is this ESG?" It is "what changed because ESG was added?" Compare the fund with its non-ESG parent index or benchmark. If the sector weights, top holdings and risk profile are almost identical, the ESG process may be light-touch. If they are very different, the investor needs to understand whether the extra active risk is deliberate and suitable.
Where ESG funds sit in the invest cluster
This article explains the category. For fund-by-fund comparison logic, move to best sustainable investment funds UK. For label checks, read FCA SDR labels. For the difference between broad ESG and stronger sustainability claims, read sustainable funds vs ESG funds.
Key takeaway
ESG funds are not a monolithic category - they range from light exclusion screening to deep impact investing. Performance is context-dependent and has been mixed across market cycles. The most important thing before investing is understanding what the fund actually holds and how its ESG approach is applied, not just the label. This article is informational only and not financial advice.
ESG funds FAQ
Are ESG funds always lower carbon?
No. Some ESG funds have lower carbon exposure, but others use governance or best-in-class scoring that may still include high-emitting sectors. Check the fund's carbon metrics, fossil fuel exposure and exclusion policy.
Are ESG funds safer than normal funds?
Not automatically. ESG factors can highlight risks, but the fund still has market risk, concentration risk, currency risk and fee risk. A sustainable label does not remove investment risk.
What is the fastest way to check an ESG fund?
Read the factsheet, check the top holdings, review exclusions, compare fees and look for a plain-English methodology. If the fund name sounds green but the documents are vague, treat that as a warning sign.
Look through the portfolio, not just the name
The fastest way to understand an ESG fund is to look at what it actually owns. Fund names can sound similar while portfolios differ sharply. One fund may exclude fossil fuel producers. Another may hold energy companies with higher ESG scores than peers. A third may tilt toward technology and healthcare because those sectors score better on some emissions metrics.
Readers should check the top holdings, sector exposure, exclusions, benchmark, voting record and sustainability disclosure. They should also compare the ESG fund with a non-ESG equivalent from the same provider where possible. That shows what changed because of the ESG methodology. If the holdings are almost identical, the sustainability benefit may be limited. If the holdings are very different, the financial risk profile may also be different. The fund name starts the research. The portfolio confirms what the investor is really buying.