ESG has become the latest buzz term in investing as social conscience plays an increasing role in financial decisions. Claire Tyrrell talks to advisers about how to balance clients' social investing expectations while still delivering good outcomes...
As the public turns its attention to living more sustainably and environmental factors play increasing roles in company decisions, environmental, social and governance (ESG) investing has made its way to the front pages.
Advisers have noted significant interest from their clients in ESG funds in 2019, but what exactly makes a fund ESG compliant, and should there be greater scrutiny around this form of investing?
Several industry experts and advisers spoke to MAR about what they think ESG should look like and the role it will play in the future of investing. Henwood Court director and Chartered financial planner Jason Ashman says the focus on ESG brings advisers' diligence to the fore.
Deciding which stocks are ESG can be near impossible because it is such a subjective area. For example, McDonald’s could be a more harmful stock than a tobacco company
"ESG funds are the label around at the moment," he observes. "It's obvious as to why there's a great interest in that area with the growth of awareness of issues like climate change. But if you go back to the fundamentals, any adviser who has been doing their job properly for the past 25-30 years has always been asking questions about ethical investing.
"It is part and parcel of what we do: properly understanding what clients' objectives are, and aspirations they've got and what's important to them."
The Adviser Centre chief investment officer Peter Toogood says fund management groups are highlighting the
ESG credentials of all the funds they manage - not just ones flagged ESG.
"All funds have ESG components, but what's changed is there's a heightened awareness from investors wanting to understand what those credentials are," he notes.
"All groups are aware that investors have a greater focus on the ESG credentials of the funds they buy. Equally, investors can choose to invest in funds that apply a negative screen - no tobacco, mining, arms etc. Or they can choose positive impact funds where the intention is to invest in companies that specifically deal with the consequences of exploiting land, labour and capital."
He says defining ESG can be problematic because it is not a financial question but a moral one: "It keeps going down to this level and one person's moral is another person's sin."
Deciding which stocks are ESG can be near impossible, he adds, because it is such a subjective area. In his mind, for example, McDonald's is more a harmful stock than a Tobacco company.
"If the (ESG) guidelines become stock specific, who decides that?" he asks. "You can't standardise a moral opinion on tobacco - some funds will invest in it, some won't."
For financial adviser Ashman the ESG label increases advisers' onus of responsibility when it comes to choosing the most appropriate funds for clients.
"Advisers should have a responsibility to understand what they are recommending to their clients, and that goes beyond simply looking at whether a fund has a certain rating - it's understanding exactly what a fund invests in and then aligning that with their client's objectives," he explains.
That said, it is crucial for advisers to avoid "greenwashing" by being seduced by a fund's ESG status or placing too much emphasis on it, Ashman says.
"You've got to be careful you don't give any more weight to the ESG objective over and above the very important objectives of having an asset allocated portfolio, which is diversified, well spread, low cost and within the risk profile of the client," he adds.
"You've got to remove yourself from the titles, the personalities and the noise and actually get down to the fundamentals. I sometimes turn around to clients and say, ‘well I understand what your objectives are, but I don't want to expose you to this level of risk'."
Ashman says ESG funds often expose clients to greater risk because they can be more concentrated. Funds are usually categorised as ESG by in-house teams at investment firms who rely on ratings from popular analytics companies, such as Morningstar and MSCI.
Tom Sparke, investment manager at discretionary management firm GDIM, argues there should be a clearer framework around ESG compliance: "There should be some more lines drawn to say ‘an ethical company should have this and this', and some sort of checklist to go through to formalise the process. We have still seen some funds that have oil companies within their ethical portfolio, which we just don't think is acceptable."
Sparke adds that ethical investing, which has evolved into ESG, has become more accessible in recent years as the social conscience has shifted.
"It has certainly got easier for us because there are ethical bond funds and ethical equity funds in pretty much every part of the world now, whereas 10 years ago… we couldn't replicate our main portfolios with ESG funds, but now we can really do it across the board," he says.
Ethical investing, which has evolved into ESG, has become more accessible in recent years as the social conscience has shifted: "Most investment companies have ESG teams now, some have got considerable support in those areas and we will favour them."
The Investment Association is working to refine industry standards around ESG and, what is more, the FCA will require advisers to ask their clients about their approach to responsible investing from January.
Toogood says ESG and socially responsible investing (SRI) are commonly confused, but that it is important to distinguish them.
"People are confusing SRI with ESG," he says. "They are not the same thing. ESG is thinking about how to invest in sustainable companies that have good governance standards and minimise their impact on the environment. Companies that don't abide by these criteria are unlike to flourish in the future anyway.
"SRI funds are either mandated to negatively screen sectors, such as tobacco or energy, or they are positive impact funds that invest in companies that aim to improve the challenges presented by exploiting the planet's resources."
For his part, Ashman points out ESG is a relatively new space and has made it crucial for advisers to scrutinise the composition of funds.
"You are getting funds coming onto the market which propose to be ESG, the reality is it's one thing saying things but how good are they at actually doing it?" he asks. Diversification, he says, is also key when including ESG in a client's portfolio.
"Like anything in any new area," he continues, "we would always look towards diversifying current investments over a number of funds, rather than simply investing in a fund, especially when there's a lack of significant track record on which we actually evidence these funds against."
LGT Vestra head of sustainable model portfolio service Phoebe Stone says the advice space is at a "fundamental tipping point" as ESG investing has worked its way into the mainstream.
"The scale of the sustainable investing sector is growing exponentially due to increased collaboration between mainstream and specialist institutions to make the market accessible and economically viable for investors," she says.
"The deluge of new products and innovators into the market to meet consumer demand means that financial advisory firms need to embrace the trend in order to maintain a competitive edge."
This article appeared in the December issue of Professional Adviser's sister title Multi-Asset Review. To make sure you receive your own copy of the next issue, please do register your interest here
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