Roadmap to ESG series - Part four

So far in our roadmap to ESG series, we've looked at how to formulate an ESG strategy that fits your firm’s culture, values and investment philosophy and meets your clients' needs and objectives. This part, compiled with help from research firm NextWealth, looks at investment decisions and how to reach them.

If you've been following the series hopefully you'll have completed the audit of your existing client portfolios recommended in part two. In that case, you will have established how well your current investment proposition serves the needs of your core client base and whether you need an alternative strategy – perhaps outsourcing to a specialist - for those clients with more defined and specific requirements.

You might also have completed a client survey (recommended in part three). In which case, you should use its insights to inform your strategy.

What are other advisers doing?

According to NextWealth’s ESG Tracker Studies in 2021, one-fifth of financial advice professionals plan to fully integrate ESG investing into clients’ portfolios, with most preferring a core/satellite approach that uses badged ESG solutions.

Other key findings include:

  • Financial advisers expect two-thirds of their client money to be invested in conventional funds with no specific ESG, ethical impact or sustainable criteria.
  • One fifth will be in funds that have full ESG integration.
  • 13% will be in badged funds or solutions with specific sustainable investment or carbon reduction objectives.

How to see through the greenwashing

Once you are clear about your firm’s ESG strategy, the next stage involves developing the framework for delivering your vision to your clients.

From the research we carried out with financial planners, this is the hardest part. The number one issue relates to data – or rather lack of it, particularly for those managing investments in-house. The other relates to the information being presented to them by investment providers and a scepticism that what they are told is over-inflated and even misleading, known as ‘greenwashing’.

“Terminology is a real issue
– greenwashing is rife.”

Alex Reynolds, Advies Private Clients

Investment providers have been quick to embrace ESG promises, but many financial advice professionals believe the marketing hype is not aligned with reality. This discord adds to advisers’ stress in committing to ESG solutions for clients. No one wants to offer options to clients that later turn out to be less accurate than the marketing blurb suggested.

Many UK advisers are looking to the FCA to help with the confusion around terminology and hope greater clarity can be achieved.

How ratings providers measure ESG performance

There is a lot of concern among advisers about the quality of the data that exists for ESG. Ratings providers should help simplify the process, but there is a lack of consistency with measuring ESG performance.

The fact is, evaluating ESG performance is complicated. Nic Spicer, UK Head of Investments at PortfolioMetrix, explains it like this in his paper ‘ESG in Investing’:

“[ESG ratings providers] collect and aggregate a range of information on a company’s ESG performance: its disclosures, third-party reports (e.g. from NGOs), news items, and proprietary research through company interviews and questionnaires.

“They come up with an overall ESG score and scores for the individual components (E, S, and G). The problem with ratings providers (and indeed with active managers who do it themselves) is that evaluating ESG performance is complicated.

“Different analysts and providers will measure the same attribute differently, perhaps by analysing diversity (as part of the S in ESG) via gender pay gaps whilst others will look at female & ethnic minority board representation. Then there is the problem of scope. One ratings agency may include electromagnetic radiation in evaluating a company’s environmental record, and others may not.

“Then there is the problem of weight. Different agencies will place different weights on individual components. Combine these differences with the inevitable human biases involved, and some quite stark differences in ESG ratings appear.

"However, despite a lack of consistency in their approaches, it doesn’t mean the ratings are “useless” or that the providers are “biased or incompetent”. It does mean that financial advice professionals need to look in detail at how the ratings are constructed before using them and use them consistently across client portfolios.

Measuring up

With such rapid growth in the number of providers offering ESG investment options, the financial advice professionals we spoke to believe there is, even more, need to scrutinise what they are offering and how that measures up to promises.

Join us next time as we look at the client-side of ESG investing and why the questions you ask are crucial for determining which investment option is most suitable.

Roadmap to ESG part 5: Implementation

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