ESG funds – data & transparency are key

ESG funds – data & transparency are key

Whilst ESG funds are not new, their popularity has surged recently, with approximately 99% of the £11.6bn invested in ESG funds since 2015 occurring in just the last two years. A reported 111 new sustainable funds were launched across Europe in Q1 this year. During the same period, €120bn flowed into sustainable European funds, the first time ESG investment was higher than for non-sustainable funds.

Reasons for this include increased public environmental awareness, growing investment opportunities and the ongoing Covid-19 pandemic. As society, and in turn governments, become more sensitive to environmental concerns, ESG finance is coming under increasing scrutiny. Reflecting this, and concerned by the number of poor-quality fund applications it was receiving, the FCA recently issued a ‘Dear Chair’ letter, warning of the need for UK firms to better protect consumers through improved oversight and control.

Incoming regulation

Whilst EU regulations call for consideration of clients’ ESG preferences, this currently doesn’t apply to UK advisers. To help eliminate confusion, the FCA announced earlier this year plans to standardise sustainable investment labels for consumers, with a focus on how advisers assess consumer needs to ensure product suitability.

The FCA stressed that a fund’s design and ESG investment strategy must be accurately disclosed, that the fund follows its disclosed objectives and that all ESG-related information be readily available to clients.

Expected new ESG requirements are not restricted to the UK, with the U.S. Securities & Exchange Commissions (SEC)  currently drawing up new rules. Focused on governance, strategy and risk management, SEC is also promising new climate-related disclosure requirements for asset managers, life insurance firms and FCA-regulated pension providers by the end of 2021.

E, S or G?

Environmental funds still dominate ESG investment, with these easily capturing the imagination of investors, and results much easier to monitor and measure. However, demand for social and governance funds is increasing, creating some sensitive and complicated issues for advisers. One such problem is that the social and governance aspects of a fund are still often overlooked, often because they are much more difficult to quantify and prove.

Furthermore, whilst a fund may do well in one aspect of ESG, it can do less well in another. For example, whilst China has made huge improvements to the cost and reliability of solar power, providing obvious environmental benefits, the country does less well from a social and governance point of view. In terms of such issues, many are pointing to the need for better ESG data.

Data is Everything

With regulatory insight still lacking, a rising bar for results/goals, and the fact that many ESG funds simply focus on looking good rather than driving actual change, the need for solid ESG data is becoming increasingly important. Whilst fund managers are using information such as emissions levels, energy usage and raw material sourcing to base their investment decisions on, there remains the need for greater transparency.

Growing adviser apprehension regarding ESG investments was recently highlighted by New Model Adviser, which revealed that 61 of 81 advisers it questioned admitted to not trusting fund managers’ sustainability claims.

Such data transparency should include what a company’s targets are and whether these are appropriate and realistic. Furthermore, ESG data is only of use when its quality can be assured.

This means questioning whether it is coming from a company itself or a 3rd party, whether it has been approved by a scientific body and what methodology was used to collect it.

Speak to Clients

Whilst it is not currently mandatory for UK advisers to understand a client’s ESG preferences, from a business point of view, advisers can no longer ignore the growing desire for ethical and sustainable investment. It is therefore important that you take the time to learn your clients’ needs in this area. This may include a preference for only investing in companies already considered an ESG success, or for investing in companies with proven equal pay systems.

One of the biggest problems advisers are facing is how to assess and integrate ESG funds into their existing advice and investment processes. Whilst some tools enable you to search for ESG funds, most lack the granular detail required to provide sound investment advice. Furthermore, many advisers still lack the experience required to effectively assess how a portfolio manager has ensured a portfolio aligns with ESG investment philosophy.