The big increase in interest from investors has transferred to strong flows of retail investor money into ESG or sustainable funds. According to the Investment Association, between Q1 2020 and Q1 2021 retail investors placed a total of £11bn in responsible investment funds. This was 38% of all new retail money during this period.
With this amount of investor interest, it is unsurprising that some investment managers have seized the marketing opportunity available, and advisers and investors are facing a deluge of material advertising investments as ESG or sustainable.
The different approaches and definitions used by investment managers has created additional confusion and this is compounded by the lack of commonly agreed standards and classification for sustainable investments. This opens up a significant space for greenwashing - using ESG and sustainability as a marketing story rather than an investment approach – and the risk of greenwashing has already prompted the Financial Conduct Authority (FCA) to warn about its rise.
This is being addressed by the FCA’s work on Sustainability Disclosure Requirements (SDR) and the government’s UK Green Taxonomy. Some of the measures being considered as part of the SDR are the introduction of a common system for labelling sustainable funds and forcing firms to clearly back up claims of sustainability when promoting these funds. But confusion is likely to persist in the short-term while these new regulations are developed.
Understanding the investment process
There is a wide range of investment approaches and styles that can be described as responsible, sustainable or ESG. Understanding the investment process used by different funds and model portfolios is key to avoiding solutions which have been greenwashed.
The Responsible Investment Spectrum of Capital
However, to truly establish whether investment solutions are living up to their billing it is necessary for investment managers to back up their claims. At the moment, there is no regulatory minimum standard to meet so the level of ESG data disclosure can vary widely and even well regarded third-party ESG fund ratings from the likes of Morningstar, ISS or yourSRI only tell part of the story. In order to see the real ESG characteristics of an investment you need to see the underlying data.
Earlier this year, FE Investments launched ESG disclosure reports to cover the ESG characteristics of all our portfolios, not just our responsible investments. We believe this is best-in-class reporting which will provide advice businesses with the detail necessary to carry out their research, and should also provide investors with a better understanding of what they are invested in. The reports show a full breakdown of where their money is invested by themes, such as education, alternative energy or clean water, and show how the portfolios align with the UN’s Principles of Responsible Investing. They also provide company level reporting showing the contributions made by individual stocks in the portfolio.
In addition, the reports provide advisers and clients with reassurance about the governance process at work on their behalf by showing the results of our monitoring of controversies involving their investments.
Finally, our reports show where our portfolios have exposure to industries which are usually subject to ethical screens. Although we don’t use blanket negative screening in any of our portfolios, it is important that advisers and clients are given full view of what they are invested in.
Putting ESG analysis to work
Our position on ESG is slightly different than much of the investment industry. We believe that ESG is a framework for analysis. It is a key part of an investment research, but it is not an investment style in its own right. ESG factors can be used to identify investments that will have a material impact on the world, good or bad, and allow this to be considered as part of an investment process.
We use ESG as a factor in the analysis in all of our portfolios, but only our Responsibly Managed Portfolios are designed to provide a positive outcome in addition to the financial returns our investors are seeking to achieve.
Our view is that no retail clients want an ‘ESG’-labelled portfolio. They want investments which adequately reflect their beliefs. ESG and the grouping together of disparate and sometimes conflicting investment styles, solutions and themes is an institutional solution which is not meeting client demand. Instead, investors want to know their investments are doing less harm, doing more good and delivering on risk and returns.
To ensure that clients are invested in the most appropriate solution means that advisers need to fully understand the investment process at work and the impact of the underlying holdings. In order to do this properly means having access to clear, detailed and comparable reporting so advisers and paraplanners have reassurance that they are meeting their clients’ needs and their regulatory requirements.
Our portfolios cover a wide spectrum of outcomes to ensure clients have enough choice of the types of investments they’d like to make. Our Hybrid, Income and Mosaic portfolios emphasise risk management, where ESG factors are part of the process but the objective not such a high priority. In contrast, the Responsibly Managed portfolios combine sustainable and impact funds together, and delivers a more progressive outcome to do more good. By doing so, we can target a broad client base and help IFAs advise their clients effectively.