Environmental, social, and governance investing has been one of the fastest growing areas in financial services over the last decade.
Turn back the clock to 2010, and not many people in the advice industry would have had any idea what it was about.
With a publicity boost during the coronavirus pandemic, ESG investing is set to make huge strides in the retail investment space after taking the institutional world by storm.
According to the UK’s Investment Association, in 2010, there was around £5bn ($6.3bn, €5.6bn) in ethical strategies, and today there is over £20bn.
That is a four-fold increase in a decade – and this only looks set to grow as governments eye ‘green’ infrastructure projects to kickstart their respetive economies.
The ESG investing space was gaining traction before the coronavirus pandemic, but the outbreak has pushed the ‘craze’ into overdrive.
Global investment manager Federated Hermes found 85% of IFAs have seen a rise in client requests to allocate capital to ESG-integrated funds since the start of covid-19.
International Adviser spoke to several firms in the financial advice and wealth management industry to understand how the sector is dealing with this rising demand.
Rebecca Kowalski, compliance officer at IFA firm Cornerstone Asset Management, said: “The most well-prepared advisers will know that best practice involves making clients aware of the options available to them across the scale of responsible investing.
“A good financial planner will also understand that there are a huge range of client objectives that can apply when building a portfolio that aims to do good.”
Gillian Hepburn, UK intermediary solutions director at Schroders, said: “In the main, we do see advisers focusing on ESG, ensuring that they are well educated and have a range of investment solutions available for clients.”
Richard Burden, head of international sales, international division at Canaccord Genuity Wealth Management UK & Europe, said: “We think that, in the post coronavirus world, ESG will have a much more significant role to play and we anticipate the ‘pull’ factor from retail investors being much more profound. The advisory community needs to prepare for this.”
Education plays a big role in this.
Most recently, investment management firm BNY Mellon rolled out its own ESG training seminar for financial intermediaries in the UK, which is designed to focus on the consideration of ESG factors when advising clients on their financial planning and investment decisions.
And in November 2019, CFA UK unveiled the first ESG qualification “of its kind” in the country.
So, do advisers have enough technical tools at their disposal to serve clients?
“I definitely think more needs to be done in the industry,” Kowalski added. “ESG is just the latest buzz word and the tip of the iceberg when it comes to building portfolios that are ready for the changes the world is expected to make. Whether it is the transition to a low carbon economy or dealing with global poverty.”
Hepburn said: “Research and anecdotal evidence suggests that many advisers are still on a journey, but some of the challenges lie around ensuring consistency of terminology and the assessment of ESG investments.”
Jake Moeller, senior investment consultant at Square Mile Investment Consulting and Research, said that “advisers should understand the difference between the various key descriptors”.
“Advisers need to be aware of these differences as the potential client outcomes within this spectrum are considerable and the level of risks vary materially within different strategies.”
ESG investing is still fairly undeveloped in the financial advice world, so clients need to be on guard and understand what it is all about.
A lot of the time, many investment scams are successful because the investor lacks the knowledge about the topic at hand.
“Investors are increasingly focused on trying to understand how their money is invested and there is growing awareness and knowledge across a wide range of these issues: from climate change and governance to gender diversity and the Black Lives Matter movement,” said Delyth Richards, client solutions group chief operating officer and head of product strategy at Kleinwort Hambros.
“Clearly, with a breadth of clients comes a breadth of knowledge, but this is not the real challenge: a lack of consistency and clear definitions means that the investor who wishes to invest responsibly must navigate a huge range of acronyms.”
Cornerstone’s Kowalski added: “I don’t think ESG is a difficult concept to explain to a client and it certainly seems to be a relevant consideration during the pandemic, with daily news reports shining a light on whether companies are looking after the health and safety of their staff and customers.
“I do think that consumers need to be aware that investing in companies that have a good ESG rating isn’t going to fix the world’s problems overnight.
“Having a good ESG score can simply mean you are doing better in some areas than your peers, with ground still to be made up on other issues.”
One of the big areas that could catch clients and investors out is ‘greenwashing’.
This is the practice of making investment funds appear to be more ESG than they actually are, which is something that has caught the eye of the Financial Conduct Authority.
In a bid to stop ‘greenwashing’, the Sustainable Finance Disclosure Regulation (SFDR), effective on 10 March 2021, will see financial market participants and financial advisers disclose how they integrate ESG factors into their investment and risk management processes.
Canaccord Genuity’s Burden said: “Unfortunately, ‘greenwashing’ prevails and does pose a threat in the retail investment sector.
“So, it is important for clients and advisers to understand what’s ‘under the bonnet’ of their investments and for them to be able to understand if these funds are what they say they are.”
Harry Merrison, investment manager at IFA firm Kingswood, said: “Certainly, care has to be taken to distinguish true ESG endeavours from corporate ‘greenwashing’. Though whether some funds are more ESG than others is almost neither here nor there.
“Whilst capital allocated to individual funds is likely to be insignificant in the grand scheme of things, critics should be wary of levelling too much scrutiny at individual funds or companies because the broader adoption of ESG principles and capital allocated has the potential to do a great deal of good regardless.”
Kleinwort Hambros’ Richards added: “Responsible investing is perhaps the most significant movement in the investment industry for a generation; yet the lack of a single, clear definition risks undermining its importance.
“The lack of an objective benchmark against which ESG factors can be analysed opens the door to ‘greenwashing’ and may lead to investors being misled by false rhetoric. The issue is actually one of variable regulation: this leads to inconsistent information which makes it difficult to analyse and limits its usefulness for investors.”
Funds in the market
However, talk about ‘greenwashing’ being a big problem is a bit premature, as there are not that many ESG funds in the retail space yet.
This is changing constantly, and IA has reported on several fund launches from companies over the last few weeks including Blackfinch Asset Management, Cornerstone Asset Management and Canaccord Genuity WM.
So, do advisers have enough options for clients?
“Products designated as ‘ESG’ is the fastest area of product growth we see, with the number of funds expanding weekly,” said David Storm, head of multi-asset portfolio strategy at RBC Wealth Management.
Richards said: “The problem is less about quantity and more about quality, at least in terms of the quality of information available to allow investors to fully understand what a fund is doing in practice to address what are clearly complex and disparate issues.”
Square Mile’s Moeller added: “There is an increasing pipeline of funds with specific sustainable mandates coming to market, water funds or green bond funds for example.
“Other funds which concentrate on some of the megatrends driving sustainability, such as technology advancements or efficient power, are also coming to market. Increasingly there is something for everyone.”
It may seem like that the rise in ESG demand and funds has been very quick, and can appear at first glance to be something of a ‘craze’.
So, is ESG the future of retail investing?
“I really hope no one invests in this area just because it’s a craze,” Kowalski said. “All good crazes come to an end (look at Neil Woodford) and I hope that ESG considerations are here to stay and will expand in their remit in future.
“ESG will play a part in the construction of traditional portfolios and will not be something provided just to investors who proactively seek it out.”
RBC’s Storm added: “The true success of ESG will be when we no longer use the terminology ‘ESG fund’, because it has become the accepted way of assessing the value of a security.
“Until then, it’s fair to say that the trends driving the need for sustainable business practices are here for the long term and embracing investments in these trends is a way of readying a portfolio for changes in the global economy.”