Why all funds becoming ESG may not be a good thing

It is easy for fund managers to pay lip service to a sustainable investment approach in their marketing material and fund name, warns ethical adviser Castlefield.

The coronavirus pandemic has changed more than just our home and work lives: it has galvanised the green and ethical investment market in a remarkable fashion. 

Studies indicate that the crisis has acted as a catalyst for investors and decision-makers to focus on more sustainable practices – and that’s reflected in the rapidly rising number of funds taking environmental, social and governance (ESG) principles into consideration. 

A report from JPMorganin July last year observed: “Once a niche, ESG investing is fast-growing in every geography, and assets indicated as following ESG principles may soon represent 44% of global assets under management.”The report added that on the broadest classification for the ESG market, “assets following global sustainable investment approaches could reach around $45 trillion in assets under management by the end of 2020”.

That outlook is mirrored by a recent survey of investment professionals from CoreData, two-thirds of whom anticipate that, globally, all funds will be incorporating ESG factors in their portfolio decisions within the next five years.

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At Castlefield we’re seeing similar trends within the industry, as more and more asset managers running conventional funds announce they are taking ESG principles on board. 

Superficially that sounds like great news, of course, particularly in light of the escalating global climate crisis. So why do we have reservations about the widespread and growing adoption of the principles we’ve been subscribing to for many years? 

The trouble is that as things stand, it is easy for managers to pay lip service to a sustainable investment approach in their marketing material and fund name, while in reality adopting a pretty light touch in that regard - a practice known as greenwashing. 

True specialists in this field appreciate the merits of having an integrated and in-depth investment approach, where ESG matters are considered at every stage of the process, as it generally delivers a more consistent approach to scoring potential companies for inclusion in a fund and managing risk. But greenwashing is easier and quicker. 

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And that potential for greenwashing raises more questions in regard to the choice facing individual investors. Do these investment managers really even know what they’re doing as far as ESG is concerned? Is it acceptable for these funds to be labelled as sustainable if their stewardship involves only relatively superficial ESG exercises? And most importantly, how can investors differentiate them from funds where ESG is deeply embedded? It is worth drilling down a little further, before trying to address those questions. 

Recently, environmental and social considerations have attracted increasing attention among investors: they’re exciting and easy to relate to. But it is in relation to governance - which covers more prosaic issues around a company’s transparency and accountability to its stakeholders – that widespread monitoring by fund managers could make a real difference. 

If requirements such as the need for directors to retain shares in the company they run for a minimum period after they depart, or for companies to adopt recommendations of the government’s Parker review on ethnic diversity, become the norm among fund managers – sustainably focused or otherwise – that will force businesses across the board to clean up their act. 

However, the problem is that investigating and challenging firms on their ESG behaviour takes time and effort, which some managers would rather avoid. In this respect, recent initiatives by the Financial Conduct Authority (FCA)could represent a big step forwards. They have issued a policy statement giving guiding principles to help firms with ESG product design and disclosure to help tackle greenwashing potential. 

As Richard Monks, the FCA’s director of strategy, said in a Good Money Week speech in October 2020: “We want to help firms deliver the reliably sustainable investment products that consumers and investors want, and we want to help consumers make better-informed choices.”

And it is arguably the latter ambition that becomes the bigger challenge as more and more funds badge themselves ESG or ethical. In the past, ‘green’ was much more black and white: because it was a niche, practiced by very few specialist providers, others had little or no exposure to it. If investors wanted a ‘responsible’ investment, it was easy to spot the relevant funds because they were badged ‘responsible’ and came from specialist managers. 

Now, with the proliferation of funds badged ‘sustainable’, ‘ethical’, ‘responsible’, ‘positive’, ‘future-proof’ or ’impact’ on the market, the investor in the street is faced with a bewildering range of choice. All promise something ‘good’, but some - and the investor doesn’t necessarily know which – are more committed, better resourced and/or more knowledgeable in delivering it. 

There is the chance that investors will gravitate towards the investment houses with the marketing clout to shout the loudest about their ESG credentials, whether or not they are backed by a strong track record in sustainable investment. 

Ultimately, I think the FCA will need to step in and provide signposts for investors. The obvious route would be to attach some clear criteria to the various ESG terms on the table. That way, investors could see, for example, that the manager of a ‘sustainable’ fund has committed to a certain list of ESG responsibilities, while the manager of an ‘impact’ fund has signed up to different or additional ones. 

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ESG is a complex and rapidly changing arena: not only are new and existing funds entering all the time but regulations are coming into play. As time goes on, a common language approach is being rolled out, and relative newcomers are likely to become more experienced and more committed, particularly with the weight of public opinion and interest behind them. 

A good example is that of Nest, the workplace pension scheme provider that was set up by the government. Only one ethical fund is offered to pension investors at the moment, but we’ve seen from recent updates that the degree of stewardship that they write about in their ongoing updates is more comprehensive than when Nest started. 

This suggests that Nest’s ethical fund managers challenge companies over issues and companies are listening to feedback. Three years ago, for instance, Amazon (NASDAQ:AMZN) was a top 10 holding; it has now been sold, even though it remains in other Nest funds, and that likely reflects reactions to controversial aspects of the company’s business model such as the way staff are treated.

If other investment houses also adopt and embed rigour around their ESG commitments over the coming years, that can only be a good thing; but the FCA will need to be equally rigorous in its guidance around greenwash. 

Haydon Waldek is a chartered financial planner and partner of Castlefield. Castlefield is a trading name of Castlefield Advisory Partners Limited (CAP) and a registered trademark and the property of Castlefield Partners Limited. The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Castlefield.