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Beware of the 'easy selling' ESG gift

Beware of the 'easy selling' ESG gift

As the environmental, social and governance universe continues to expand, investors should beware the bandwagon jumpers, warns Miton Opitmal's Paul Warner.

He writes: 

Back in 1994, when we were first asked to run discretionary ethical portfolios, we had just 21 funds from which to choose*.

That portfolio was called the Green Portfolio. In those days, if you asked a question at a fund seminar or lunch that related to ethical, environmental, social, or governance issues (ESG), other participants would look at you as if you were stuck in the age of the hippies.

A decade on and the number of funds available had risen to 41*. Throughout that period the funds were predominantly ethical funds, screening out companies using negative criteria, the main ones being gambling, tobacco, pornography, alcohol, arms and animal testing.

An example was the Jupiter Ecology fund which, although it did have negative criteria, was looking for companies that had solutions to environmental and sustainability problems.

A number of the funds that were then available to us still exist today, although many have gone through a number of name changes and ownerships. For example, NPI is now Janus Henderson funds, Scottish Equitable is now Kames, Allchurches is now EdenTree, and Norwich Union now Liontrust.

Setting up portfolios
In 2009, we were asked to set up some SRI portfolios (socially responsible investing). This was an evolution away from the negative screening of the ethical funds towards positive screening, where funds were looking for companies that were solving the evolving problems caused by the increasing impact of an ever-growing human global population.

A number of positive screening funds also explicitly screened out some of the sectors the old ethical funds had. Others were investing in sectors, like alternative energy, which would not have companies in the ‘bad’ sectors.

We now had 93 funds to choose from, helped by the fact that platforms made it easier to invest in ETFs, investment trusts and the then-FSA recognised offshore funds, as well as Oeics and unit trusts. The concept of sustainability was now being recognised by investors.

The new acronym which seems to appear on virtually every page in any press article relating to investment is ESG.

The cynic in me would suggest that this acronym stands for something like Easy Sales Gift, and that cynicism is reinforced when I see all the new products coming out that seem to be jumping on the bandwagon.

According to MSCI, ESG investing began in the 1960s as socially responsible investing. A little chicken and egg there.

ESG first came into being in 2004 when the then secretary general of the United Nations, Kofi Annan, invited financial institutions to develop guidelines and recommendations on how to integrate ESG issues into asset management, securities brokerage services and associated research functions. 20 institutions participated in producing a report published in December 2004 called Who Cares Wins.

The concept of ESG became more prevalent post the financial crisis. It was evident that failure of governance and consideration of social implications were contributory factors to the crisis.

We also have the fact that the millennial generation are fast becoming investors, and according to surveys are more likely to want their investments to have a positive impact on the world.

Impact is another new buzzword which has moved into the mainstream investment jargon, but which should really remain a niche area for investors with very large sums of money.

The problem with ESG is that it means different things to different people. The providers of indices look at it from a different angle to many SRI investors.

The index providers and many institutional investors look at ESG from the angle of assessing the risks inherent in a business that could affect its value. They look at E, S and G separately and create an ESG score.

Most create a measure from 0 to 100, where 100 is most ESG compliant. They create these measures by applying metrics to answers on questionnaires that are completed by large companies. The questions are different for different industries.

Risk factors
Additionally, which to some extent demonstrates the difference from an SRI investor’s concept of ESG, if a company has an ‘unmanageable’ risk, it is factored out of the ESG calculation. For example, an oil company is not able to fully eliminate its risks related to carbon emissions so it is factored out.

To give you an example of how different this is to the SRI concept, at our recent quarterly investment meeting we had a debate about whether an ETF holding physical gold would be acceptable in our SRI models.

At the end of the debate it was agreed that it was not acceptable for two reasons. Firstly, a gold ETF was not doing anything positive. Secondly, where and how the gold came into being was not accessible and the process by which it had been mined, processed and delivered could have contravened many ESG principles.

From a financial adviser’s point of view, ESG is an Easy Selling Gift. If their clients are asked whether they would like their portfolio to do good and not to do harm with no material impact on overall performance, or would they prefer a portfolio that could invest anywhere including companies that can do harm, what would they prefer?  

 Paul Warner (pictured) is head of portfolio management at MitonOptimal

* Source: Vigeo Eiris

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