Few would argue there has been a great deal of ‘talk’ around responsible investing, sustainability, environmental, social and governance (ESG) and related issues over the past year. Regulators have talked a lot about how such concepts should be defined, fund managers have talked a lot about their ESG credentials, while governments have talked a lot about ‘building back better’ and their shiny new green agendas.
The ‘walk’ on responsible investing, sustainability and ESG has, however, been harder to spot. The range of products available to advisers is missing crucial elements – multi-asset and alternatives, to pick out two. Risk-rated products are thin on the ground. More importantly, there is little standardisation, meaning asset managers could, if they were of a mind to, still game the system.
Nevertheless, the sector is developing rapidly and considerable progress is being made. While fund managers and policymakers are likely to keep on talking, can investors and their advisers expect evidence of real action in 2021?
Powerful force
While there may be altruistic reasons for fund managers to up their game on sustainability, there are also sound financial ones. “ESG has become a powerful force over the past year,” says FundCalibre managing director Darius McDermott. “It has been around for 25 years and has been called ‘ethical’, ‘SRI’ and various other names, but the problem to date has been that no-one really bought it. In 2020, people were actually buying it.”
Morningstar data supports that view, indicating flows into sustainable open-ended funds and exchange-traded funds (ETFs) available to European investors hit €233bn (£200bn) in 2020 – almost double the figure for 2019.
The regulatory agenda has also heated up, pushing for tangible action from fund managers. Notably, as discussed in more detail on p24, the EU’s Sustainable Finance Disclosure Regulation came into effect on 10 March, imposing new reporting requirements on fund groups. Though watered down from earlier drafts that were seen as excessively prescriptive, the reach of the legislation is likely to expand over time. The EU’s Taxonomy is also due to be adopted later this year, which ought to bring some standardisation to the language and definitions surrounding sustainable investments.
McDermott also points out that, while existing strategies from fund groups with an established pedigree in sustainable investing – the likes of Aegon, BMO, Schroders and Stewart Investors – have seen rapid growth, there has also been a swathe of launches in the market. “There have been dozens of global sustainable funds launched, plus impact funds with a range of different targets,” he adds.
As definitions have improved and index providers have found ways to incorporate sustainability metrics, it has become easier for passive fund groups to release new products as well. Legal & General Investment Management has launched ETFs focused on green
bonds and hydrogen, for example, while Invesco introduced a Global Clean Energy Ucits ETF. Franklin Templeton, Lyxor and Tabula Investment Management, among others, have meanwhile launched Paris Agreement-aligned ETFs. This is also improving the range of products available to investors and their advisers.
Equally, while the vast majority of sustainable funds are still equity-oriented – 196 out of 293 at the last count, according to Square Mile Investment Consulting & Research – there have been launches elsewhere. As discussed further on p14, new ‘green bonds’ to fund infrastructure development have created more choice in the fixed-income market. There are also green property and infrastructure funds coming to market. Asset managers have also realised the imperative for sustainable multi-asset funds for advisers and are slowly addressing this particular gap in the market, too.
The ‘S’ factor
Many fund groups would argue they are already ‘walking the walk’ on the ‘E’ of ESG. M&G, for example, recently announced it would no longer invest in thermal coal as part of its overall aim to achieve net zero carbon emissions across its investment portfolios by 2050. Carbon emission and pollution are relatively easy to measure and many companies already offer good disclosure on their environmental impact.
Equally, the ‘governance’ aspect of ESG is well established within most fund groups, covered off through AGMs and reporting requirements of listed companies. This is bread and butter for most investment managers and ‘G’ coverage has duly expanded in recent years.
It is the ‘S’ factor that seems to have been most neglected by asset managers. “The social element of ESG investing has been stubbornly difficult to understand and historically challenging to get the measure of,” says MainStreet Partners managing director Simone Gallo.
“It has been much like the fabled middle child – largely excluded, ignored and often outright neglected in favour of its environmental or governance siblings. Last year, all that changed. The catalyst was the Covid-19 pandemic. Finally, questions were being asked about whether ‘big’ businesses were contributing positively to society and whether it was right for profit to be prized above all else.”
Gallo expects fund managers to direct more focus on this area over the next few years, examining the impact businesses have on both the internal and external stakeholders of organisations. “There are challenges,” he says. “The complex web of stakeholders goes some way to explaining why the assessment and measurement of a business or fund’s societal impact can be so difficult. Another challenge lies in deciding where the accountability should end, as often it is not the direct investment but another company somewhere in its supply chain that pursues questionable practices in terms of societal impact.” Regardless of the challenges, however, walking the walk on social issues will be vitally important for the long-term sustainability agenda.
Increasingly, fund groups are putting ESG at the heart of their portfolios and giving more responsibility to their ESG teams. They also want more nuanced and tailored advice. This means beefing up their in-house firepower, rather than buying in external research.
“The big focus for us is building smarter tools, systems and data sets to help investment decision-makers in real time,” says Royal London Asset Management (RLAM) head of responsible investment Ashley Hamilton Claxton. “Achieving the right mix of quantitative data and qualitative insights is absolutely key.
“This is helping asset managers ‘walk the walk’. We regularly have conversations with fund managers about changing holdings in portfolios to target better-quality ESG or lower-carbon companies while maintaining the same or better financial or risk profile. It is through many of these small stock-by-stock decisions or weighting adjustments we start to build meaningful change.”
Reporting standards
According to Square Mile director of responsible and sustainable investing John Fleetwood, reporting standards remain mixed. “We always look for evidence to back up fund manager claims,” he says. “We want to see clear reporting to demonstrate the impact they are having. That means an impact report and an engagement report and the quality here is really important – it cannot just be case studies. On engagement, for example, I would want to know what would happen if a fund group does not manage to make progress with a company.”
There are still some big gaps in data availability, too, Fleetwood adds, even if this is steadily improving. “Large companies have to report on areas such as gender or carbon, but they might not have data on waste consumption or social metrics,” he says. “It may be difficult to obtain full data on their supply chain, for example. It is getting better all the time, however, and
the next five years will see a huge change.”
Ultimately, says FundCalibre’s McDermott, the rise of the impact fund may lead to greater transparency from companies and fund groups. “Such funds have an explicit ESG impact or are looking to create a positive change,” he says. “Any fund that uses ‘impact’ in its title will need to demonstrate to buyers it does what it says it does.” Measurement and reporting should then become correspondingly widespread.
The final piece of the puzzle will be engagement. As engagement reports become more prevalent, the tangible results of engagement activity will become clearer. RLAM, for example, points to its recent engagement with the UK utility sector, where it is working hard to encourage companies to develop plans to adopt renewable energy.
When it comes to responsible investing, most asset managers have learned how to ‘talk the talk’ but, increasingly, those looking to play a real role in this crucial area are now standing up to ‘walk the walk’ – turning admirable words into meaningful action.
