Environmental, social and governance investing

Did you groan and roll your eyes? Shame on you! Shame! If there's anything the last few weeks of climate change protests or the continued distrust in financial services since the 2008 crash has shown us, is that this is a concern that isn't going away anytime soon.

Investing responsibly is nothing new. Charities have been doing it for years, long before corporate governance and responsible investing came into vogue. Let's re-focus and think about the challenges facing advisers and clients in this area.

Remember the days when 'ethical' investing was something that only really 'green' people used to ask about? You know the type; their hair was a wee bit frizzy, their kids were badly behaved, they wore old cardigans and smelled a bit (we've got a word for that in Scotland – foosty – look it up).

Outrageous stereotypes aside, nowadays it's difficult to pick up a trade publication or attend an event without hearing about the latest ethical development in the sector. Whether that be a new investment fund, a new piece of corporate governance or a change in corporate responsibility protocols. All sounds delicious.

We're suspicious types at the lang cat so we tried to get a handle on actual investment demand in our recent adviser census1. We asked our adviser panel about the demand they had seen from their clients for socially responsible investments and whether that translated into actual usage of ethical investments;

  • 74% of respondents said that they use or consider socially responsible investments as part of their client investment proposition.
  • However, only 5.7% of respondents reported that there has been a significant increase in clients asking them about socially responsible investments in recent years. 33.8% reported a slight increase with 60.0% reporting no real change.
  • For 80% of advisers, the socially responsible component of the overall investment proposition is less than 10%

Interest in ESG doesn't appear to be going away but that the pace of demand doesn't appear to be matching the wider socially-responsible tone of voice in other aspects of society.

That's a lot of percentages to digest, so what does this tell us? It tells us that interest in ESG doesn't appear to be going away but that the pace of demand doesn't appear to be matching the wider socially-responsible tone of voice in other aspects of society.

There is some appetite for them, which presents an opportunity – for fund houses, for advisers and for investors. Sounds like a win, win, but the fact ESG represents quite a low proportion of advisers' business, suggests something is going on. Is it the lack of availability? Confusing terminology? Are ethical beliefs skewed towards the younger generation, with no investible assets? Poorer returns? A combination of all?

Investing responsibly is nothing new. Charities have been doing it for years, long before corporate governance and responsible investing came into vogue. Let's re-focus and think about the challenges facing advisers and clients in this area.

Confusing terminology and lack of clarity about who does what makes it difficult to compare investments. There's no scale of 'how ESG' one fund is to another; the green scale doesn't apply here (that's so early 2000s). There's also the confusing distinction between a provider being a 'responsible investor' although not offering ESG funds. Ultimately, for a client with strong ESG requirements, it can be difficult for them to find their route to market, either themselves or via an adviser.

And on that adviser point, we wonder if the march towards centralised investment propositions is playing a part too. Uptake of model portfolios in recent years has been huge, whether on an in-house or out-sourced basis, and the industrialised nature of these makes it difficult to step outside of the process for someone with bespoke demands. Technology can play its part here and make it easier to accommodate the altruistic beliefs of more foosty, sorry, altruistic customers.

On the provider side, it's easy to be wooed by lots of talk of robust processes, screening processes, experienced teams and watertight belief systems, but care should be taken when considering how to position the fund for the client – as part of a wider portfolio or as a single investment. Asset allocation, risk tolerance, capacity for loss and all those good things trump all.

Despite 'ethical' hitting puberty and developing into ESG, it's only recently that we've seen ESG portfolios with a more packaged solution feel breaking through. Perhaps the reluctance of advisers to embrace this market hasn't only been down to murky definitions or perception of lower returns, but because most existing solutions haven't been based on consumer research. There is very little research out there which asks consumers what they want and at what cost. We need to determine just how far the dedicated ethical investor or the socially conscious voyeur will go, or whether they'll have to compromise to meet their investment goals.

The next step in the evolution is in motion with the FCA collating responses to its discussion paper DP18:8: Climate change and green finance2 It'll be interesting to see how this influences FCA actions. We, as financial services professionals and people, should all have some responsibility for where we put our (and our clients') money and there are things we can do to help mature the ESG market. This isn't just moral grandstanding. We need to listen to consumers of all kinds to establish the levels of ESG they want and need. Providers need to take note.

And we need to collectively get better at defining this issue. Throughout this article we've been deliberately guilty (shame on us!) of conflating terminology all over the place. Ethical funds, socially responsible investments, corporate governance et al. All lumbered into the one pot. We suspect this isn't helping the issue and it's one we're going to be doing a bit of work on this year. Watch this space.

Visit www.langcatfinancial.co.uk for more from Steve and the rest of the lang cats.

  1. 235 members of the advice community took part in State of the Adviser Nation in December 2018.
  2. The FCA is collating responses following its discussion paper; DP18/8: Climate change and green finance in October 2018, so we can expect this to inform FCA actions in the following areas - pension investments; green finance products; disclosure to investors; and new reporting requirements