There can’t be too many people across the Financial Advisor landscape in Ireland who have not heard of the phrase ESG. Environmental, Social, Governance (ESG) investing is very zeitgeist currently, and a perfect storm has emerged in terms of its growing popularity. Legislative, climate, and ‘millennial’ trends are all combining to make ESG investing one of the most topical discussion points in the market.
But when you first hear about ESG or sustainable investing, what comes to mind? Millennials and their avocado toast? Wealthy people who have made their money and can afford some philanthropy? Or just a new angle for fund managers to promote funds on the back of?
Whilst there are always new topics, funds and investment strategies coming to market it does appear that ESG is here to stay and is more than just a passing trend. However, it can be hard to nail down exactly what it means and how managers can incorporate a process into not only specific existing funds, but also into their overarching house philosophy and style of investing. For example most active managers will rightly argue that taking into account social and governance factors is just part of being an a prudent investment manager, but might have concerns about the economic impact of excluding or minimising exposure to certain sectors of the market, which may still be profitable and therefore ‘good’ investments. At the other end of the scale are index tracking funds who, whilst they can have an ESG strategy, are somewhat compelled to buy the stocks that are part of their benchmark/index – excluding any metric other than Market Capitalisation, or company size. But how about we start by asking – what are the considerations that go into ESG?
Inadequate governance and compliance
In general ESG can be another valuable input into stock selection and can represent an economic approach (depending on the price). ESG is not the investment panacea and the jury is still out on whether it is the route to enhanced investment performance. ESG increasingly does not represent an exclusionary approach for low ESG rated companies.
The regulatory viewpoint
Environmental, social, and governance (ESG) related investment, also known as sustainable investment or corporate social responsibility, continues to draw interest across the world from a regulatory perspective. With greater transparency to the underlying investments of a fund or holdings of a firm, many are urging rules that would require companies to disclose comparable, decision-useful ESG information. Regulators are now tasked with determining what a standardised ESG reporting framework would look like.
The pressure is coming from a number of areas – IORPs II legislation will enshrine requirements on trustees of Pension schemes across Europe to include ESG considerations in their decision making across multiple areas. In Nordic countries, where it has been prevalent for a number of years, investing without ESG considerations is uncommon. PEPP, which stands for Pan-European Personal Pension, will contribute to the EU sustainability agenda in the financial sector in multiple ways. Most notably by name checking the Paris Agreement, UN Sustainable Development Goals and the EU Commission directives on Sustainable Finance as items that should be taken into account when considering an investment.
.Lack of Standardisation
There are a number of ways in which insurance and fund management companies can incorporate an ESG perspective into their business operations. The companies they invest in via their equity investments are the most obvious, but equally effective measures would include carbon neutral workplaces (clean energy), green impact investing, and selectively excluding coal related companies from Group underwriting and investing activities, and to extend coal exclusions to policyholder funds. A number of firms also support the Paris Accord on combatting global warming. Despite significant appetite for impact investing, there are daunting barriers to greater adoption. One is the lack of standardisation in measuring the ‘impact’ of investments.
The Financial Times reports that investors are struggling to quantify the environmental impact of their investments. Both advisors (34%) and investors (61%) agree that it’s a difficult to measure. The CFA institute has also recently reported that there is no standard framework to measure a carbon footprint, and this is a common theme throughout the area of ESG.
Finally, ESG is more prevalent in equities – but does your client want a 100% equity portfolio? This is not the right risk level for the majority of investors, but from an ESG perspective it is certainly the most advanced asset class. Fixed Income is catching up and in the corporate bond space a lot of the metrics applicable to equities are also relevant. The Sovereign bond space is less advanced, but ESG Multi-Asset funds are beginning to emerge.
However, whilst the conversation and interest in the area is growing – the fund flows haven’t quite caught hold just yet. For example, a recent BNP Paribas survey cites that 80% of investors in Italy have a ‘willingness to invest’ in a ‘socially responsible investment’ yet only 7% actually do currently. The lack of information is an obstacle to more widespread investment, but that is changing and fund managers and product providers are clamouring to portray their expertise in this area. Interestingly, the BNP survey, also points to a connection between interest in ESG investing and events such as the UN Climate Change Conference. In essence, if interest continues to grow in the mainstream media this will seep into people’s investment mindset. However everywhere it holds true that the gap between a fundamental interest in the area and actual investment offers huge potential. I am usually loathe to point towards ‘millennial trends’, but it is hard to discount the effect that the mindsets of younger investors is having in this area.
What can advisors do?
Firstly, you will need to have an opinion in this area, and if advisors don’t have some knowledge in the area it can be perceived as a lack of expertise from potential clients. Fund flows are small now- but will grow. Succession planning is just as important from an advisor’s perspective. The over 60s are the most asset rich demographic in the Irish market. Similarly, the majority of assets are lost to an advisor once they are passed down to the next generation. Having an ESG view is one of a number of ways to connect and appeal to a younger target market – who one day will be the most asset rich demographic in the Irish market.
However, it’s not all good news. The above in theory appears relatively easy to implement, or at least have a foundation knowledge of. However, ESG is often spoken about in terms of equities and this is where most of the potential solutions lie – but many an investor who wants an ESG consideration have no appetite for a 100% equity portfolio. ESG also continues to mean different things to different people, and it can be easy to get caught up in offering a personalised, tailored approach which is hard to keep on top of – and difficult to justify.
In conclusion, the fundamental goal of investing really hasn’t changed. We invest capital today, in the hope/expectation for a better, or wealthier future. However, what constitutes ‘better’ or ‘wealthier’ may well be changing. This cannot be ignored.
The development of ESG products is likely to grow further and you have a great opportunity to strengthen your brokerage by using them. The benefits of offering ESG solutions are likely to far outweigh the drawbacks, but there will be challenges. While the industry continues to grapple with the best way to incorporate ESG preferences into previously standardised practices, initial research into the area could put you ahead of competitors in the industry. Ultimately enhancing your proposition and providing value to both current and prospective clients.
Author: Ian Slattery is an Investment Consultant with Zurich Life. Information about investing with Zurich can be found at https://www.zurich.ie/savings-and-investments/
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