Do ESG stakeholders know as much as they should?
A lack of in-depth understanding of environmental, social and governance issues among the diverse stakeholders involved in sustainable investment can trip up the sector’s progress
The Green Horizon Summit earlier this month is evidence that environmental, social and governance (ESG) Investing is high on the agenda of business and government. More than 100 global business and climate leaders, including the Prince of Wales and United Nations secretary-general António Guterres, took part.
Business leaders, asset managers and institutional investors are already clued up on the benefits of ESG investing. Yet for sustainable investing to become mainstream, it needs the support of financial advisers, corporates and retail investors.
Figures from the Investment Association suggest the amount invested in stocks and funds with ESG characteristics could be 50 per cent greater than in 2019, thanks in part to high-profile campaigns by Greta Thunberg and Sir David Attenborough.
“There has been a massive increase in interest in sustainable investing in recent years,” says Martin Shaw, chief executive of the Association of Financial Mutuals. “Consumer research indicates people are looking to support more ethical and environmentally-friendly companies.”
However, judging the appropriateness and performance of different funds is difficult unless you have an intimate knowledge of how the money is invested, he says. Even then, there is currently no universal method for classifying the green content of investments.
Defining ESG investing
One of the issues, says Angela Hayes, partner at law firm TLT, is the lack of a common approach among firms in describing sustainability objectives. There are no common standards for measuring whether sustainability objectives are being met.
“Without this clear regulatory framework, retail advisers will be naturally more cautious about advising their clients to buy green investment products,” she says. More standard language and metrics would also help retail investors to learn, understand and make decisions about the products available.
Indeed, one of the sticking points for the wide-scale adoption of sustainable investing is having a meaningful definition, says Jeff Waller, senior director and head of financing solutions at sustainability consultancy ENGIE Impact.
“Investments that are labelled ‘sustainable’ fall along a wide spectrum. An investment can be deemed sustainable if it simply screens out companies that don’t meet a minimum threshold of ESG factors, like those in the tobacco and weapons sectors,” he says.
One solution might be to create market-accepted guidelines, such as those for green, social and sustainability bonds.
“If the rest of the industry adopted similar frameworks across the sustainable investing landscape, it could bring a level of transparency that could help the market grow,” says Waller.
The role of independent financial advisers
A poll of 200 UK independent financial advisers (IFAs) by the international business of Federated Hermes found that 82 per cent reported an uptick in inquiries from investors about how their capital can be committed to combat the effects of climate change, raise governance standards and improve human rights.
Pete Drewienkiewicz, chief investment officer of global assets at Redington, argues the pressure towards sustainable investing is now coming from investors.
“It is important for investment advisers to hold the asset managers to account to help get everyone on the same page, because I don’t think the asset owners are going to tolerate inaction much longer,” he says.
New European Union regulations on sustainability will apply from March 2021 and will require financial advisers to provide information to enable investors to make informed investment decisions based on ESG factors.
“To really drive change, we need to see fund managers changing the way they allocate portfolios to meet the growing impact demands of their clients and to prevent tokenistic investing with an ESG or impact label,” says Daniela Barone Soares, chief executive of Snowball, an impact investor.
ESG data and investor scrutiny
Asset managers and IFAs have the potential to be change-makers because they are able to drive change with the weight and influence of the capital they manage on behalf of their clients, says Richard Ker, partner in the financial services practice at Odgers Berndtson.
“Companies with poor ESG credentials should expect to see greater scrutiny from asset managers and asset owners more broadly,” he says. “Capital will naturally flow to companies with strong ESG credentials, which in turn drives better performance.”
Jeffrey Mushens, technical policy director of The Investing and Savings Alliance says IFAs will need to cater for these changing investor preferences and field more queries about the ESG rating of existing investments.
This is particularly true when dealing with millennial investors, who take a much more ethical stance on investment.
“IFAs need to be one step ahead of the curve to ensure they can advise on these wishes of the younger demographic who care about sustainability,” he says.
Patrick Sheehan, a founder and partner at ETF Partners, says the investment industry is responding to the more extensive changes happening in society and needs to be aware of the new investing credentials of younger generations.
“The real issue is that we face societal change and younger generations are moving the needle forward,” he says. “The younger generations are driven by purpose and we see a generational shift towards purpose, perhaps because of the bigger crises the world is facing, and in parallel we are seeing and experiencing investment demand.”
Who makes the biggest impact to sustainable investing?
William Burrows, managing director at AHR Private Wealth, says the shift towards sustainable investing has largely been driven from the bottom up. Grassroots climate change movements, the #MeToo campaign and investors have all led the charge and applied pressure to businesses to change their image and place sustainability at the heart of what they do.
These movements have also influenced governments to encourage sustainable investing. The economic uncertainty caused by the coronavirus pandemic has made advisers and clients reassess their perceptions of value and adjust portfolio allocations accordingly.
“Many investors have used the crisis as an opportunity to adapt their portfolio to new or changing views about the importance of sustainability as climate change becomes ever-present on the news agenda,” he says. This and the relative strong performance of many ESG funds during the pandemic has led a growing number of consumers to embrace sustainable investment practices.
Investment advisers will need to rethink their role in the future and change the way they work with clients, says Dr Emilio Marti, assistant professor at the Rotterdam School of Management, Erasmus University.
“Discussing sustainable investing with clients often pushes traditional investment advisers outside their comfort zone,” he says. “When it comes to sustainable investing, investment advisers need to solve problems together with clients.”
The education gap is already shrinking
Ilaria Calabresi, sustainable investment lead at J.P. Morgan Private Bank, says it is the need to stay competitive that will drive companies towards sustainability in the future.
COVID-19 has accelerated change, and Celene Lee, principal and senior investment consultant at Buck, argues that any education gap which previously existed between institutional investors and large corporates, has already shrunk dramatically.
“With ever-increasing access to sustainable investing information, such as carbon emissions data, consumers and investors have been able to begin building a picture of who is doing well and who is not, on the sustainability scale. It’s this knowledge that is beginning to shift the balance in terms of capital flows towards more sustainable businesses,” she says.
Josh Gregory, founder and chief executive of Sugi, concludes: “What’s needed is a different way of presenting sustainable information to retail investors as well as financial advisers and corporates in a way that’s directly relevant to them and their needs.”