The changing face of ESG for advisers

In the face of hard science and changing consumer behaviours, the investment world is transforming to meet growing demand for values-driven investment strategies.

7 October 2020

Strong historical performance, resilience to crises like the current coronavirus pandemic, and the likelihood of accelerated future momentum all demonstrate the value of investing through an environmental, social and governance (ESG) lens. Fund managers and advisers increasingly recognise that ESG investments improve long-term financial returns and mitigate risks. Advisers also report that ESG investing encourages greater investor engagement and dialogue and that higher ESG allocation has considerable impact on their businesses with longer client tenure and more enduring relationships.

"Despite its increasing popularity, ESG investing is still an evolving concept with developing regulatory and application frameworks."

Despite its increasing popularity, ESG investing is still an evolving concept with developing regulatory and application frameworks. In this environment, advisers report that there are few standards for them to share a common understanding of the functions and features of ESG. With ESG transitioning towards ‘business as usual’ and more advisers discussing investment options with their clients, the market needs to standardise around clear and distinct definitions and meanings.

ESG investing is an approach for developing different strategies incorporating ESG principles in line with investors’ needs. As such, ESG terminologies and strategies aren’t as interchangeable as some advisers currently believe. Investment visions and outcomes, for example, differ greatly between ‘responsible’, ‘sustainable’ and ‘impact’ investors – a clearer understanding of differing applications and impacts may become an essential part of due diligence for many advisers in the future. Greater standardisation will make it easier for advisers to understand the differing ESG integration practices of investment houses and match client preferences to suitable products.

Work is already underway to develop a common ESG taxonomy for investors and advisers. In January 2019, the Investment Association launched a widescale consultation to propose an industry-endorsed set of terminology and methodology definitions. It also sought to assess reporting frameworks and design a labelling system for investors and advisers to identify suitable ESG funds. The same year, the EU Commission’s Technical Expert Group on Sustainable Finance published reports on a common EU classification system and industry standards for ‘green’ funds and low-carbon investment strategies. These reports were designed to help drive the transition towards sustainable economies and shape future ESG regulations. In September 2019, CFA UK launched the first domestic Certificate in ESG Investing, aimed at delivering the skills and benchmark knowledge required by investment professionals to incorporate ESG factors into their investment processes and demonstrate high levels of competence.

Regulatory change also accelerates the need for commonalities in ESG definitions and standards. The MiFID II directive expanding the requirement for harmonised financial regulations across the EU is due for separate implementation in the UK in 2021. In part, it requires advisers to incorporate ESG preferences into their suitability processes for selecting investment products. The shortfall in common definitions and standards suggests many advisers may not be adequately prepared for rollout. Whether or not this specific regulation becomes mandatory, the momentum and tone of the regulatory universe is clear.

"Currently, over £17 trillion of invested global assets adopt responsible investment strategies with significant annual increases reported"

Another consideration for advisers is the increasing consumer appetite for ESG investing and a shift in generational investment attitudes. Currently, over £17 trillion of invested global assets adopt responsible investment strategies with significant annual increases reported. Advisers also report that ESG discussions with clients have increased considerably during the last five years.

Nevertheless, some advisers still maintain that there’s little interest expressed in ESG investing among their existing clients; three-quarters of respondents to a Money Marketing survey in July 2020 said that fewer than one in five clients had asked them about ESG investment options. With many advisers catering primarily for the retirement market, this may be more reflective of an outdated, traditionalist view that investors considering ESG face a binary decision: align investments with values or choose performance.

This generational distinction is important. By 2025, millennials will comprise 75% of the US workforce, a dynamic likely to be repeated elsewhere in the world. The generation voicing the loudest demands for improved environmental, social, and governance stewardship will shortly hold a majority share of global earnings and investment power.  While it’s difficult to predict a decisively causal connection between a rise in millennial spending power and accelerated ESG investment, recent evidence suggests intent and momentum: among the results of DoSomething Strategic’s 2018 Survey of Young People and Social Change, for example, 67% of respondents said they would refuse or consider refusing to buy from companies who behaved contrary to their values.

Transformative regulation and an emerging, values-driven investor base should alert advisers to the fact that change is inevitable. In its wake, advisers are asking for more: more uniformity regarding ESG language and definitions; more comparative data on historical financial performance; more access to suitable products. Alongside the pleas for clarity, however, advisers must themselves be part of the dialogue shaping the future of ESG investment while there’s still room for negotiation.