Environmental, Social, and Governance assets are on track to exceed $50 trillion by 2025 demonstrating the attractiveness of those three letters ‘ESG’ among investors. Citywealth’s April French Furnell asks the industry, what challenges lie ahead as ESG products increase but reports of different standards brings confusion to investors.
Top of the agenda for this maturing market is tackling the scepticism among investors over greenwashing which is misinformation or exaggeration of green credentials to capitalise on growing demand.
A recent report Investing for Global Impact 2021 produced by Campden Wealth on behalf of Global Impact Solutions Today (GIST) and Barclays Private Bank, found that 76 per cent of private wealth holders surveyed said they were concerned about making an investment that has been greenwashed. The survey looked at data from 300 private wealth holders from 33 countries with an average of $833 million assets under management. Commenting on the findings, Damian Payiatakis, Head of Sustainable and Impact Investing at Barclays Private Bank, said “It’s an extraordinary figure for experienced investors which demonstrates they still have concerns over what an investment does and are trying to navigate the marketing around this subject.”
Judging by different markers
One of the reasons investors might be struggling to understand the impact of their ESG investments is that the market approaches ESG in so many different ways. “Approaches include adopting a purely exclusionary approach; avoiding activities such as armaments or tobacco that are often of concern; building an analysis of financially-material ESG risks and opportunities into the investment process; taking a best in class approach, where no sectors are excluded outright but companies with the best ESG ratings in each industry are included; investing according to positive themes such as climate change or health and well-being; or indeed a combination of all these approaches”, described Kate Elliot, head of Rathbone Greenbank’s ethical, sustainable and impact research team.
This isn’t necessarily a bad thing, if it’s properly understood by investors. “In one sense, this variation in offerings is a good thing as it makes it more likely that there are options out there to suit different investors’ financial and sustainability objectives. But it can also make it incredibly difficult to navigate the marketplace and understand what you are investing in and whether it aligns with your values”, she added.
“The challenge is that lots of investors believe they are investing in ESG and using their wealth to have an impact, but the impact they are achieving might fall below their expectations as it can be unclear what the deep underlying assets are”, said Wim Ritz, Global Head of Funds at ZEDRA. “This is why transparency from funds on their processes and underlying holdings is key”, added Elliot.
Financial regulators have made it increasingly clear that they will take action against firms misleading the public about the climate credentials of their products. Earlier this year the UK’s Financial Conduct Authority (FCA) brought asset managers, life insurers, pension providers and standard listed companies within the scope of climate-related disclosure rules. While at the moment it’s only consulting on climate-related disclosures it said that its ESG Sourcebook within its Handbook would expand over time to include rules and guidance on wider ESG topics.
The FCA also published a letter in July to the chairs of Authorised Fund Managers setting out its Guiding principles on design, delivery and disclosure of ESG and sustainable investment funds. The FCA sets out three examples of behaviour which could be described as greenwashing, and summarised that it was not seeing ‘sufficient, clear information explaining a fund’s chosen strategy and how this related to the assets selected for the fund’.
Investment manager style may also vary
The EU has introduced similar rules requiring fund houses, insurers and pension funds to begin disclosing how sustainable they really are, as part of a suite of new rules. In addition, the US and German regulators are currently investigating Deutsche Bank’s asset management arm, DWS Group, as published in Private Equity News, claiming it painted a rosier picture with its sustainable investing criteria than it was delivering. However, a DWS spokesman said the company stood by its annual report and that an investigation by a third-party firm found no substance to these allegations. The spokesperson said “standards for defining ESG assets are constantly evolving, and that DWS has been seen by the market as being more conservative than most of its competitors.” Adding further complication for investors in choosing a manager to fit their risk appetite.
An industry in transition
With more and more money flowing into sustainable funds, representation needs to be fair and clear according to Professor Calderini, Director of Tiresia, the Politecnico di Milano School of Management’s Research Centre for Impact Finance and Innovation and a member of the G8 Task Force for Social Impact Investment during its early years of operation. He describes the movement as having an “identity crisis” and believes that increased regulation and litigation will force investment funds to be more compliant, while also helping them to find their own identity. “It’s an industry in transition”, he said.
Opportunity for advisors
Confusion among investors is also an area of opportunity for wealth management advisors to demonstrate their value to clients by helping them understand what their portfolio is doing and assist on making investment decisions. “With over 60 classifications of green bonds, we don’t expect an investor to muddle through them all. Lots of education of investors is needed but part of it will happen naturally as the global conversation marches forward. There will continue to be a reliance on the knowledge of advisors and professionals, and for those advisors who want the education on ESG, it’s there”, said James Penny, Chief Investment Officer of TAM Asset Management.
The missing ‘s’ and ‘g’
A final challenge for the ESG movement is the focus on the ‘e’, at the expense of social and governance policies. It has been argued that governance in particular is ignored at a company’s peril, as effective governance is necessary to achieve environmental and social policies.
With the media attention on COP26 this autumn, it’s perhaps unsurprising that the market is flooded with environmental products. “There has been a lot of investment driven off the narrative in the media this year which has included environmental disruption from hurricanes and floods, to coverage of COP26. Many investors are led by what they are reading and are motivated to invest in what they see around them. If you’re a fund manager looking to launch a new fund, you’re going to launch where the appetite is so it’s a bit like a chicken and egg situation in terms of supply and demand”, said Penny.
Payiatakis cautions, “To effectively assess a company, investment managers must bring the ‘s’ into consideration. Labour management, employee conditions, fair trade, ethics and diversity, these are all critical and financially material factors to a company’s long-term success. How companies manage these issues will impact how they are viewed as employers in the future. While it might not have the same visibility, for thoughtful investment managers, it is part of their overall thinking.”
Another reason for the lack of funds focused on social and governance aspects is the lack of availability of consistent and comparable data to assess risks and opportunities. Measuring diversity or labour practices doesn’t boil down to a single statistic but there are useful indicators to assist with considerations. Payiatakis points out, “While the statistics in absolute terms are helpful, we’re really interested in what it actually means and moreover how it's used within the investment decision making process. Without these second order considerations, they just become vanity metrics.”
Moving forward, Elliot believes there is a shift away from thinking of the e,s, and g as siloes. She explained: “At Greenbank, we’ve always recognised the importance of social factors in assessing potential investments and the need to look beyond those impacts that are easily quantifiable, to understand the overall sustainability impact - positive or negative - of an investment. Within the wider investment community, we’re seeing a trend towards this way of thinking and the breaking down of previously siloed thinking around ESG issues”.
Social – re-skilling of jobs to prevent negative impact
An example Elliot draws upon is that of the concept of a just transition. “It recognises that the low carbon transition will involve widespread and significant changes to our economies and lifestyles, creating significant impacts on communities and employment at a local, regional and even global level. Investors are, therefore, increasingly building these broader social concepts into their dialogue with companies around their decarbonisation strategies - for example, by understanding if and how companies are supporting workers in at-risk roles to reskill for new opportunities in low carbon industries.”
What’s next for ESG?
As the ESG market grows, many of these challenges are to be expected. Overall the market seems confident that ESG has got traction. While greenwashing is a reputational issue and the ‘s’ and ‘g’ need to be further addressed, these are hurdles to overcome. Payiatakis concluded, “It’s not unusual for a market in an adolescent stage of its maturity, and I’m optimistic they’ll be addressed.”
An agenda is a debate
As Ritz reminds us all, “We live in exciting times. This is an evolution and while we might not see a complete move from traditional investing to ESG investing in one generation, ESG considerations will continue to be very important and those who don’t change will be signing their own death wish”.
Perhaps the way to look at it is: if you go on stage with an agenda, you have to accept not everyone's going to agree with it.