Financial advisers are used to talking to clients about the big issues in life, such as the historic certainties - death and taxes. I also think that change resulting from climate change is another certainty that will significantly impact the world we live in and invest in.
As a result, we need to include this matter in our conversations and make sure we are comfortable discussing the implications.
Finance is one of the key pillars of the UN Climate Change Conference (COP26) agenda and to quote from the official COP26 website: “To achieve our climate goals, every company, every financial firm, every bank, insurer and investor will need to change.”
You may see this as a fantastic opportunity, a responsibility, a challenge, or a risk. Some of you may even, like me, feel it is a privilege to be part of something so momentous.
Actions of course speak louder than words, but good communication is key to the success of our industry and the stakes are too high here not to get the message right.
So how is the conversation going?
Before we even examine our discussions with clients (more of that next time) how well are we communicating with each other about the various ways of investing that take account of the good or the bad things that companies do?
We’re certainly making a lot of noise about this subject, but I think we’re having some difficulty finding the words to express what we want to say.
While I understand the need to make a potentially complex and unfamiliar subject simple, I am concerned about the widespread popularity and proliferation of those three little letters, ESG.
My conversation starter is that it’s time to put ESG back in the box in which it belongs and only bring it out when it’s safe to do so. Imagine if we had a quota for the number of times we can type or read ESG before our laptops seriously over-heat, just like we have a budget for the amount of carbon emissions we can produce before the planet goes the same way.
Taken directly from the CFA’s Introduction to ESG Investing text:
“ESG investing is an approach to managing assets where investors explicitly acknowledge the relevance of environmental, social and governance (ESG) factors in their investment decisions, as well as their own role as owners and creditors, with the long-term return of an investment portfolio in mind. In other words, ESG investing aims to correctly price social, environmental and economic risks and opportunities.”
ESG is therefore a term used to describe the clever stuff that investment managers do when building portfolios, selecting the underlying companies and managing those assets.
It’s driven to a great extent by the motives that I imagine will drive most fund managers – delivering performance, whether relative or absolute, managing risks and attracting funds under management. It is said that eventually all investments will take ESG into account, because why would you not consider environmental, social and governance issues when weighing up whether to invest or lend? Why would you ignore anything that might be a risk or an opportunity for a company?
Having established the official meaning of ESG and acknowledging that it is an intelligent, sensible, forward-looking practice, I would like to focus on what ESG will probably not be.
ESG will probably not be:
1. The reason the client has come to speak to you.
2. Enough to differentiate you from the pack.
3. The right solution for clients for whom the exclusion of all the ‘bad’ companies is non-negotiable, whether bad for them means tobacco, fossil fuels, animal testing, tax dodging or something else.
4. The best way to meet the coming FCA requirement to consider client’s sustainability preferences when making recommendations. Not all clients’ sustainability preferences will be to ensure that their investments incorporate ESG considerations.
ESG should not therefore be used as an umbrella term for all types of portfolio or fund that consider non-investment related factors when selecting the companies that it holds.
Depending on their personal interests, human connections and life experiences, each of your clients will have their particular pet hates and passions and will set varying levels of importance on the ability to align their finances with these. This is what makes up the ‘sustainability preferences’ that the FCA would like us to consider.
Is the right umbrella term therefore sustainable investing?
You could make a good case for this; it has been my moniker of choice for a while.
This may be because I tend to hang out in the wider community of sustainability aficionados (not just sustainable finance, but sustainable business, sustainable consumerism, sustainable use of natural resources etcetera), which means I feel on comfortable ground with this word and what it represents.
However, sustainable investing can be used within the investment industry to specifically refer to portfolios that positively select the companies they invest in. These will be companies that offer solutions to environmental and social issues or contribute in some way to the UN Sustainable Development Goals (SDGs).
That’s not how an ESG strategy works and is very different to the ethical approach, where a portfolio is based around excluding companies.
Another contender for the umbrella term of choice is responsible investment
As recommended by the Investment Association. However, this term is defined as follows by the UN PRI: “a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership.”
Investing responsibly therefore means that you select your investments with ESG in mind and become a good owner of those companies, engaging with their board/ management to encourage improved behaviours.
Responsible investment cannot therefore be used as a catch-all description, as not all funds that incorporate ethical exclusions and sustainability themes will meet this definition.
It's tricky isn’t it? Just like death and taxes!
Some might argue that it doesn’t matter whether we use the label ESG, sustainable or responsible investing, as long as we make our clients aware of these options and offer them suitable solutions.
It does matter however if a vendor sticks a Prada label on some Primark shoes or only offers an off-the-shelf solution to someone whose personal values mean they need something more exclusive.
The FCA’s recent ‘Dear CEO’ letter to authorised fund managers demonstrated that they are very concerned about the creation of funds that do not deliver what their name might suggest in terms of positive impact, avoidance or change.
Referring to ESG integration, it says: “Where a fund integrates ESG considerations into mainstream investment processes (with no material ESG orientation in the fund design/strategy), we do not expect to see prominent ESG claims in the fund’s name or documentation, or ESG positioned as a key part of that fund’s offering.”
Perhaps this warning will reduce the ESG chatter within the fund management world and in a trickle down effect, other industry players will take more care to bear the right labels.
In November we will know whether Glasgow has hosted a truly historic COP, a meaningful set of agreements that could lead the way to a world in which we can all flourish. Leaders from 190 nations will come together and many different languages will be spoken. I hope that by then, as an industry, we will be using our own language a little more carefully.