Advisers caught out by Fundsnetwork filter should have done their homework

Morningstar removes socially conscious filter from web tools after SCM Direct highlights shortcomings

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Any advisers caught out by a Fundsnetwork fund filter that incorrectly labelled funds as “socially responsible” should have checked fund literature to see that the funds had no such objective.

The search function on Fidelity’s advised and D2C platforms delivered a list of 49 Fidelity funds, despite the asset manager describing only two – the FT Sustainable Water and Waste and Fidelity First ESG All Country World funds – as being “explicitly tailored for ESG”.

A Morningstar socially conscious flag had been the basis for the categorisation. Fidelity has ceased using the search filter on its platforms while it conducts an investigation into the matter.

Morningstar head of EMEA Mark Roomans said in a written statement to Portfolio Adviser that the filter was too broad in the context and may have caused misunderstanding. “Therefore, following a review process, we are in the process of removing this filter from our web tools,” Roomans says.

The funds research house also provides the Sustainability Rating, based around ESG risk, and a Low Carbon designation.

‘Morningstar is not the regulated entity giving the advice’

Any advisers caught out by the fund filter should not just pass the buck on to Morningstar, says Planworks managing director Nathan Fryer.

“Personally, I think that given Morningstar is not the regulated entity giving the advice, any adviser relying solely on ratings and filters needs to carry out further due diligence on the funds it is investing in for its clients,” Fryer says.

Others in the industry also felt fund pickers should be taking a proper look under the bonnet of responsible investments.

“It is clear that just a cursory look into the largest holdings within many of these funds, let alone their KIID documents, would show that the primary focus of the funds is not ESG,” says SCM Direct co-founder Alan Miller. His firm, SCM Direct, which he co-founded with his wife Gina Miller, published the report, which looked at greenwashing across the funds industry.

“Everyone should take responsibility that whether inadvertently or not, they have helped fuel this greenwashing epidemic,” Miller adds.

The Fidelity European Dynamic Growth Fund, for example, has no mention in its objectives and investment policy of an ESG or ethical approach.

That fund was highlighted in the SCM Direct report for the 6.2% it held in tobacco companies.

A quick glance at the September factsheet reveals British American Tobacco and Heineken both appear in the top-10 holdings, while the latter is one of the largest overweights.

Even the FCA finds it confusing

While it is important for fund pickers to conduct proper due diligence, Fryer acknowledges the difficulty of getting a simple understanding of how and why a proposed solution is meeting its claims to be socially responsible.

He points out the FCA said as much in its climate change and green finance paper published in October.

The regulator says there can be “legitimate causes” for differences in sustainability assessments of products. It also says it is difficult to determine the net impact of the product.

“Ultimately, our focus is on ensuring that investors and consumers are not misled or mis-sold products that fail to meet their needs,” the regulator said.

Responsible investment isn’t simple

But the fact responsible investing isn’t simple is what the industry and the regulator need to get their head around, says SRI Services & Fund Ecomarket founder Julia Dreblow. Fund Ecomarket was launched to navigate the diverse approaches across the funds universe and has around 100 filters that intermediaries can sift through.

Dreblow points to the Morningstar Sustainability Rating, which is not the same socially conscious flag Fidelity had used on its platforms, which employs an ESG approach where it looks for companies that are best in class, even if they operate in unethical industries like fossil fuels. That can catch investors off guard if they don’t grasp the difference between an ESG and ethical approach.

She points to LGIM, which was singled out in the SCM Direct report for its sin stock exposure in the L&G Future World ESG UK Index fund, as an example of why this approach works.

“LGIM also has a strong reputation for engagement (stewardship) activity – whereby they use their position as major shareholders to encourage better business practices,” she says. “This activity is absolutely crucial if we are to successfully transition to a lower carbon economy as we need to use shareholders powers to influence problematic companies to do better.”

DFMs find shortcomings in third-party data

Wealth managers with responsible investment portfolios that Portfolio Adviser spoke with favoured proprietary approaches to assessing funds.

“Relying on data providers tends to give you a view on a snap shot in time, they do not take into account processes or the intentionality of the ESG characteristics, which means things can change quickly,” says Ben Palmer, investment director at Brooks Macdonald, which unveiled a responsible investment service a year ago.

“Most data providers will also provide a score based on an incomplete data set which may skew the output.”

Brooks builds its own investment universe and then conducts further due diligence to decide if funds align with the firm’s Avoid or Advance mandates.

EQ Investors also finds shortcomings in using third-party sources to screen funds for its impact portfolios. It uses third-party ESG data across portfolios but for its Positive Impact portfolios it employs in-house analysis.

Impact specialist Louisiana Salge says EQ starts by establishing the social and environmental impact of the products and services offered by the companies held by a fund. It examines whether those are aligned with the UN Sustainable Development Goals.

Third-party data providers tend to focus much more on the sustainability of operational activities rather than core revenue generating activities, Salge says.

As well as analysis of underlying stocks, EQ also assesses the strategy and rules applied by the fund managers it is invested or looking to invest in.

Finding a standardised approach to responsible investment

Even within different categories of responsible investment approaches vary, notes UKSIF campaigns and communications director Charlene Cranny.

An ESG strategy might focus on the top 20% of companies or it could include the top 75%, Cranny says. Then investors have to think about methodology being used to score companies in the first place.

On ethical funds, she notes one person’s opinion of what constitutes a sin stock may differ from the next.

The European Union is currently working on environmental finance standards so green funds, just one area of responsible investing, will become easier to police.

“Until then, we urgently need to help investors make properly informed choices not hinged on a fund’s name and top 10 holdings,” she says. “I’d love to see a simple dashboard showing us all a fund’s holdings, which combination of strategies are being used, engagement targets and anything else investors want to see.”

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