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Has ESG’s rapid growth cost the sector its soul?

Has ESG’s rapid growth cost the sector its soul?

Investor interest in ethical investment has reached a tipping point in recent years: a sector that was once privately disparaged as a domain of sandal wearers and lentil fans is now the hot tip for fund houses looking for growth areas.

UK sector assets rocketed from £9.5 billion to £16 billion over the three years to 2018, and have near tripled over the decade, according to statistics from the Investment Association, which only records the deepest green, negatively screened funds.  

However, that increase – coupled with fudged terminology about what is sustainable – has led some sector veterans to warn that the reputation of the sector is at risk from terminal dilution by opportunists and marketing departments. Positive stock screening and woolly stakeholder engagement principles risk misleading buyers about what they are investing in.

To many investors who helped originate the sector, environmental, social and governance (ESG) has gained the world at the expense of its soul. 

 

Raising the bar    

Ian Richards, global head of responsible investment at Columbia Threadneedle, said the issue has reached the level of the European Commission. The Commission has proposed a strictly regulated set of enforceable criteria for ethical funds, which are expected to launch by late 2020. 


This is likely to be highly disruptive for any fund intended to be sold into the European Union, according to Richards, with the bar for describing an investment as environmental set higher than it has been by the overwhelming majority of asset managers.

‘It will only be applicable in dark green impact strategies,’ he said. ‘I spoke to one of my counterparts, who manages the global leading environmental impact fund, and his reaction to it was, “only 10% of my portfolio qualifies”.

‘People focus solely on using green indices or they are concerned about the trade-off they are going to make,’ he said. ‘Group pensions managers say, “if I have to choose between prioritising the EU’s policy objectives and closing the pension deficit in my portfolio, I will choose the second”.’


ESG data costs

Richards uses the Sustainability Accounting Standards Board framework, as well as financial stewardship, which he said leaves the firm with 77 dedicated models for different sub-industries.

‘If you see how much is spent on ESG data, Turkey’s inflation has no comparison. The cost is becoming astronomical and this will make things worse.

‘Many people assume anything that says ESG is black or white, but the reality is more complicated and this is where active managers have an advantage. It’s about creating proper analytics that will deliver what clients want, whether ethical alignment or impact investing.’

 

Sell-outs

Meanwhile, on the funds buyside, Rathbone Greenbank head John David (pictured below) has laid the blame for this squarely at the door of asset managers and corporate engagement teams. He said marketing at the fringes of the sector has invited intervention.

 

He pointed to a weakness for product specialists to add a largely meaningless ‘layer of engagement’ to their investment strategies, and on the other end for Plc boards to adopt undemanding governance criteria.

‘We have concerns that companies are choosing selectively to focus on the positives while losing sight of the broader picture and ignoring other parts of their operations trying to greenwash them,’ he said.

Lee Coates, founder of IFA business Ethical Investors said the only way to be sure a fund manager and end investor were not going to find themselves in conflict over inclusion criteria was by introducing strict negative screening.  

To this end, he chooses vehicles that follow the same principles of exclusion, such as the Kames Ethical Equity and Janus Henderson Global Responsible Managed funds, as well as the Liontrust range.

‘Many groups want to be seen like they’re doing something rather than really doing it,’ he said. ‘There are a lot of very vague companies, and the fund manager groups carry on investing as they were before, but they are looking at a positive story about
a stock.

‘ESG means you don’t have to do anything, because it doesn’t mean anything. You can buy, for example, British American Tobacco just because it has an environmental policy, so you carry on with your normal investment strategy without making any changes.’

 

Get picky

Both Coates (pictured below) and Rathbone Greenbank’s David agreed that for those who can afford it, concentrating on bespoke client preferences is a far safer route to positive impact investment than merely choosing a fund that advertises itself as ‘sustainable’.


But Columbia Threadneedle’s Richards said that even here outcomes can be distorted by inadequate sector analysis. The sheer amount of available research, as well as its eye-watering costs, could lead managers to make decisions based on inadequate material.

‘There are a lot of people who aren’t clear about what they’re doing and it’s all high-faluting saving the world,’ he said.

‘You can deliver the financial return, risk management and social impact, but it has to be done properly, and it’s not a quick fix, buy-it-off-the-self research.’

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