ESG’s mainstream integration – how can advisers help?
Environmental, social and governance (ESG) issues were growing in popularity before COVID-19 hit but have gained impetus over the summer with an acceleration of investor interest.
Indeed, growing awareness of the climate crisis has accelerated sustainable investing’s move into the mainstream. The stats reflect this: the value of global assets applying ESG data to drive investment decisions has almost doubled over four years, and more than tripled over eight years, to $40.5tn in 2020 according to a report by Opimas. The number of ESG-themed strategies has also skyrocketed over recent years. The Morningstar universe held almost 400 ESG strategies in 2019, compared with around 160 launches in 2016.
Emma Wall, Head of Investment Analysis at Hargreaves Lansdown, comments: “ESG has really captured the imagination of investors. This is a good thing in itself but also as part of a broader play where, as an industry, anything that can help to engage investors and capture their imagination is a good thing in the context of financial education and awareness.”
A tool to engage investors
How then can advisers capture this interest and drive the ESG investments journey?
Regulation is one component that will undoubtedly help. As part of MiFID II next year advisers will be required to include ESG requirements in the suitability process. This brings ESG on from being considered in terms of the pure investment, to take it into account as part of the risk process.
The AIFMD and UCITS directives will also see sustainability risk integrated into new rules and guidance, with added transparency requirements that aim to aid investors.
“Firms are responding to regulation and guidance,” says Wall. “We are following the terms used by the Investment Association which uses ‘responsible investing’ as an umbrella term and then delves deeper into its component parts: ethical, impact ESG etc.
“We have appointed an ESG lead to ensure that our advisers have the right research, both in house and externally, to ensure they can approach ESG with confidence. We have also reviewed our questions within the fact find and reframed things so that we are looking at this from a risk as well as ethics perspective.”
Building awareness of the terms
Reframing terms means that investors have more awareness of the difference between various responsible investment facets. For example, there is a massive difference between ethical, which could involve screening out certain industries or companies, and ESG which is more about having an ESG overlay as part of ethical considerations but also as part of broader risk analysis.
Excluding certain sectors or companies could have quite a large impact on performance compared to the index, where such sectors like mining and alcohol are included. Impact investing too tends to be more volatile than the index as it is usually in newer areas such as clean water technology.
“We think that a useful way to frame this is a ‘doing no harm’ approach through investments,” explains Wall. “It also ties in well with a risk approach where you are looking at sustainability over the longer term and companies and sectors that operate sustainably are more likely to have longevity and perform well. This is something to be mindful of when investing for the long term and into pension funds. When ESG is framed like this it makes total sense.”