What are ESG funds and are they worth investing in?
ESG funds invest using environmental, social and governance criteria alongside financial ones. They are among the fastest-growing investment categories globally — and among the most debated. This guide explains how they work, what the performance evidence actually shows, and what to watch for before
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 before making any investment decision.
ESG funds invest using environmental, social and governance criteria alongside financial ones. They are among the fastest-growing investment categories globally — and among 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, or exchange-traded fund (ETF) — that selects or weights its holdings based on environmental, social, and governance factors alongside standard financial criteria. The underlying theory is that companies with strong ESG characteristics face fewer risks, are better managed, and are better positioned for the long term.
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 (fossil fuels, weapons, tobacco, 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 most 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. Best-in-class funds remain diversified across sectors.
Thematic investing — concentrating on specific ESG themes: clean energy, water, sustainable agriculture, 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 — that better-governed, lower-risk companies outperform over the long run — remains contested in the academic literature. What is clearer is that ESG funds reflect specific portfolio tilts (sector weights, factor exposures) that will help or hurt depending on market conditions. They should be evaluated on their actual composition, 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 — no clear explanation of how ESG criteria are applied
- SFDR Article 6 classification — the lowest tier, meaning the fund has only basic ESG disclosure, not a sustainability objective
- High overlap with the standard index — if the holdings are almost identical to a conventional index, the ESG label is largely cosmetic
- No third-party ESG rating cited — if the fund does not reference an external ESG data provider, it may be self-assessing
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 — ESG funds often charge more
- Check the ESG methodology document if published
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.