Befuddled advisers face barrage of ESG questions from clients

69% have been asked by clients about responsible investing in the last six months

In a few short years, ESG has moved from the fringes of fund management to a preoccupation for fund groups. The push has come from the regulators, particularly for institutional funds, but on the retail side, it is increasingly coming from clients. Advisers ignore it at their peril.

The adviser audience at the recent Square Mile investment conference showed 69% have been asked by clients about responsible investing in the last six months. However, there remains considerable confusion on the right approach, whether it impacts client returns and whether investment companies that claim to have strong ESG credentials really deliver in practice.

ESG versus approaches that go above and beyond

For Jennifer Anderson (pictured), co-head of sustainable investment and ESG at Lazard, today’s ESG is about cutting edge research and stewardship: “The first driver is that there are real complexities from climate change and social inequality. These are fundamental megatrends that are important for us to understand. Secondly, good stewardship is part of our fiduciary duty. As such, ESG should be part and parcel of any research.” For Anderson, responsible and sustainable investment goes a level above that. Companies that are sustainable have to pass an additional hurdle.

For fixed income, it is a little different. There is no proxy voting, so it is difficult to have as much influence. However, Marty Dropkin, global head of research – fixed income at Fidelity, it is about engagement, working with companies to influence them to behave more sustainably.

The ‘shocking’ gap between what companies say and what they do

Fund management groups are clamouring to show their ESG credentials, but how can investors tell the difference between a company that is genuinely committed to this area and one that is merely ‘greenwashing’?

Gareth Davies, head of responsible investment distribution at Columbia Threadneedle Investments, says: “It is all about who is doing the work: Is there a well-resourced dedicated team of responsible analysts, living and breathing it every day? It is critical that companies scale up resource in this area and give those analysts the tools they need through, for example, data science and big data. Advisers need to look at whether funds are built on a solid foundation of expertise.

“But also, you need to look at what they’re holding,” he adds. “Give them a sniff test.” He believes there can be a ‘shocking’ gap between what companies say and what they do in practice. Equally, advisers shouldn’t place all their faith in labels provided by rating agencies. Davies suggests that they can give misleading results and may be too ‘black box’ in their approach.

There is also a question of integration. If the internal ESG analysts can be ignored by the portfolio manager, the system is worthless. Anderson says: “The portfolio manager is important: if you ask them about ESG, the portfolio manager needs to own the dialogue on that. It’s about good due diligence and it does rely on asset managers to have thought about how they explain it to clients.”

Retail flows following in institutional footsteps

To date, the institutional market has led the way, particularly the Northern European asset owners. The Swedish AP pension funds been told by the government that they should be ‘exemplary’ in their approach to sustainable investment. Anderson says that as an active equities manager, it is almost impossible to win business from European institutions if an investment management business isn’t good at ESG.

The retail side, however, has not progressed as far. But as wealth passes down to a new generation with different values, there is a huge opportunity. To be successful, fund managers will need to understand client requirements and they may be different to the institutional investor priorities – they may want specific climate or vegan funds, for example.

There is still a significant minority who believe that investors must sacrifice returns to incorporate ESG considerations (around 40%, according to a conference poll). This won’t wash, says Dropkin, retirees need to pay bills. He believes that funds should not benchmark against a sustainable index, but against a standard index. Companies need to show that they can invest sustainably and outperform an index.

Anderson believes that the performance perception is a legacy from SRI and ethical funds. She adds: “I would encourage people to revisit what sustainable investing is and what it looks like today. Lots of funds underperform. People tend to be comparing lots of different styles and approaches. It’s very simplified to say sustainable criteria are part of the problem. It’s more about picking a good manager.”

Could we see a mass reallocation of capital in response to ESG? Stephen Jones, chief investment officer at Kames Capital says: “If you’re not looking at the non-financial factors that have a material impact on the financial statements, you’re not doing your job and that’s what the future is about. It is now possible to look at these factors in a way that hasn’t been possible before.” Not only that, it will become a legal requirement. It will become impossible for investment managers to say that they don’t integrate ESG.

Ultimately, the technology may allow fully bespoke portfolios, where investors can pick and choose the criteria on which they invest. This would indeed be a brave new world and one that advisers should be ready for.

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