There are many shades of green to consider when incorporating ESG investments as part of your investment philosophy or recommending them as part of a client’s investment portfolio.
Whilst many Advisers and Investors acknowledge and believe in why ESG investing is important. It can be more difficult to know how to implement ethical investment strategies that align with personal beliefs and values.
As a first step, it is vital for an adviser to investigate the various approaches to responsible investing to understand the similarities, differences and areas of focus.
For example, while some responsible investment approaches are oriented around managing environmental, social and governance (ESG) risks, other approaches focus more on pursuing ESG opportunities. While most responsible investments will target market-rate financial returns, some impact investments will intentionally deliver below-market-rate returns in order to maximise the social or environmental impact.
When looking at a fund, there are different shades of green referring to the level of ethics or social responsibility intrinsic in the business and investment model on all levels. The darker the shade, technically the more ethical the fund or investment may appear.
“The whole concept of light or dark green, is very subjective” – says Paul Garner, Senior Financial Adviser at Novo Wealth and Board Member of the Ethical Advisers Co-operative.
He further explains that “Fund managers must make choices about the balance between what they’re trying to achieve on an ESG level, versus what they’re trying to achieve on an investment return level. So they’ll do that by saying we’ll invest in these companies and filter out these companies (known as applying a positive and negative screen). In some instances, they may also adopt a strategy that says, as long as no more than 5% or 10% of revenue isn’t derived from this particular area (i.e. mining practices or fossil fuels etc) then it can be included for investment. It’s important for Advisers to be aware of this as there will be a certain sector of clients who will have no tolerance for that particular area, and therefore this fund for those people wouldn’t be appropriate”.
Alexandra Brown, Founder of Invest with Ethics, Head of Research at Altiorem and Board Member of the Ethical Advisers Co-operative offers further explanation of the level of consideration that is required.
“For example, if a fund excludes tobacco, do they have a 0% threshold – (which would be the deep green scale), or do they have a 10% threshold meaning that they could still potentially hold an investment in a supermarket that sells tobacco, (which is a lighter green scale)”
James Harwood Senior Portfolio Manager at Russell Investments says “There’s been quite a lot of academic studies that show the different ESG scores vary quite a lot between different providers…. Some of the ESG scorings have been too generic” This has led to their focus on the financial materiality as a more practical metric for assessing investment performance.
In time as demand increases, it is likely that as an industry, ESG and Socially Responsible Investing will deliver more transparency, better disclosure practices and consistency of product labelling.
For now, there remain no agreed industry standards to measure or benchmark the “greenness” of an investment, or how deep ethically an investment practice goes.
“I think eventually we’ll end up with an accounting standard for ESG measures, just as we have accounting standards for financial returns”. And so when you read a set of accounts, you can be confident that they’ve met certain minimum standards that will be the same carbon footprint, or social responsibility etc.” says Phillip Moffitt, Co-Founder Beckon Capital, Director at Aware Super and Director at Green Road Consulting.
According to RIAA, the responsible investment sector is one of huge diversity, where a range of investment ESG methods and approaches are used in addition to fundamental financial analysis. These include, but are not limited to:
- ESG Integration – Inclusion of environmental, social and governance factors into the investment decision-making process.
- Negative/Exclusionary Screening – Exclusion of certain sectors, companies or practices based on specific ESG criteria.
- Minimum-Standards (Norms-Based) Screening – Screening of investments against minimum standards of business or government practice, for example as based on international norms such as those issued by the UN, ILO, OECD and NGOs.
- Corporate Engagement and Shareholder Action – Employing shareholder power to influence corporate behaviour, including through direct corporate engagement (i.e. communicating with senior management and/or boards of companies), filing or co-filing shareholder proposals, and proxy voting that is guided by comprehensive ESG guidelines.
- Positive/Best in Class Screening – Intentionally tilting a proportion of an investment portfolio towards positive solutions, or targeting companies or industries assessed to have better ESG performance relative to benchmarks or peers
- Sustainability Themed Investing – Investment in themes or assets and programs specifically related to improving social and environmental sustainability (e.g. safe and accessible water, sustainable agriculture, green buildings, lower carbon tilted portfolio, community programs).
- Impact Investing – Investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.
Interestingly, “Engagement practices are fast becoming the deciding factor of whether a fund is a deep green, whether they are just talking the talk, or whether they’re actually walking the walk, because it gives you a sense of the culture of the fund manager, and whether they take their stewardship role seriously”, says Alexandra Brown.
Tools have been created to support advisers with the process of assessing how green an investment actually is. One such tool is the Ethical Fund ratings designed by the Ethical Advisers Co-Operative (EAC). First established in 2011 by a dedicated group of financial advisers, it aims to provide guidance to those seeking to adopt and implement investment strategies that align with their personal values.
The Co-Op recognised the opaqueness of ethical investing and the time that it takes to go through all of the research and information and created a Leaf rating system to assess funds and investments. The ratings do not include financial information about the funds (such as investment performance or fees) but do assert the funds’ ethics on things like the fund’s environmental and social credentials, including underlying investments, their research and screening methods and their voting records and engagement on important issues.
Concerns about the “how-to” incorporate more ESG should not stop any Adviser from including ESG in client portfolios’ if there is demand. There is a range of tools, education and support services available to help Advisers find the best path forward to meet their business and clients’ needs.
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This article was written based on discussions held in the XY Adviser Podcast Ethical Investment Series # 13 “50 Shades of Green” hosted by Fraser Jack in conversation with Elizabeth Hatton, James Harwood, Paul Garner, Alexandra Brown, Philip Moffitt. The full podcast can be found here.
