In praise of choice

Technology made lockdown feasible, facilitating remote working and ecommerce, while the healthcare sector delivered Covid-19 treatments and vaccines with unprecedented speed. In addition, governments focused fiscal packages on environmental initiatives, such as transport and renewable energy. Meanwhile, industrial demand cratered, augmenting the relative performance of funds with no exposure to the oil and mining sectors. Likewise, the weakness of many financials stocks was positive as banks tend to perform poorly against sustainable metrics.

This year we are seeing some of these factors unwind. Despite this more challenging environment, which is impacting the relative performance of sustainable funds, inflows continue to be strong. Investors increasingly understand that sustainable investing doesn’t have to mean weaker performance: indeed, over the longer term, we believe that considering a wider range of risk factors is likely to improve returns.

At times of rapid change, it can pay to step back. While many developments have undoubtedly been positive, other elements have arguably been less so. The sheer number of new funds being set up may involve compromises in standards. With so many new managers entering the sector, there must be a risk that ‘me too’ funds, with poorly designed investment processes, deliver sub-optimal results. It would be naïve to believe that the asset management industry is above greenwashing.

You might think that I would be happy that there are efforts to impose more structure on the sector. However, I’m ambivalent about this. While no one would oppose regulation that applies clear standards and helps investors to make informed choices, more prescriptive frameworks could ultimately disadvantage investors.

In 2019, the UK’s Investment Association introduced its Responsible Investment Framework as “the lack of a common language has been a significant barrier to date to the promotion and growth of responsible investment.” Following widespread consultation with the industry, the IA’s framework introduced clarity and consistency “to make it easier for all savers to understand the opportunities available to them”. This is clearly good for investors.

I’m less enthusiastic about more recent developments. Two related pieces of legislation, the Sustainable Finance Disclosure Regulation (SFDR) and EU Taxonomy Regulation, have significant implications for the industry. I’m broadly happy with the SFDR as it will give investors more transparency, yet asset managers will have the choice of how to classify particular funds according to standardised categories. However, the Taxonomy Regulation feels more prescriptive, imposing an inflexible structure that may not be so positive.

At its heart is an apparent assumption that diversity is bad. This seems surprising as other sectors, such as global equity funds, thrive with diverse approaches offering investors a range of solutions. Instead of diversity and choice in sustainable investing, this more directive approach risks over-concentrating funds on limited parts of the market, leading to potential bubbles.

It’s not hard to set up a new fund and buy the top 50 sustainable stocks according to an external data source. However, we prefer to take a more informed approach based on a rigorous investment process that has delivered strong returns across a variety of market conditions, supported by in-house fundamental research, risk management and high standards of reporting.

Within this, we weight equally a stock’s sustainable score against its financial metrics – stocks with compelling sustainable credentials can be terrible investments. Equally, good sustainable companies that we identify early through diligent research can be driven up by weight of money until it’s right to take profits. Selling at the right time is important in delivering good investment returns.

Choice is generally considered a good thing. In asset management, as well as reducing the risk of bubbles, it also helps advisers to better match their clients’ values and principles. Educating and empowering investors, while maintaining a diversity of investment approaches, would be a credible alternative.

The value of investments and the income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested.

Find out more about our range of sustainable funds at rlam.co.uk/sustainable

Mike Fox is Head of Sustainable Investments at Royal London Asset Management.

For professional clients only, not suitable for retail clients. This is a financial promotion and is not investment advice. 

The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and are not investment advice. 

Issued in May 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.