- Empirical research into ESG investing has shown evidence of a positive effect on returns, or at least no performance penalty. Companies that behave responsibly and incorporate ESG principles into their business are usually better custodians of capital and, in turn, provide higher long-term returns (whereas the exclusionary screening of ‘bad’ sectors or industries we saw in the past generally has a negative effect on returns as managers may no longer be selecting the most ‘efficient’ investments)
- The fact that the MIFID II rules will soon require advisers to ask clients about their ESG preferences and take these into account when assessing the range of financial products to be recommended. Fund and portfolio recommendations will need to match each client’s individual ESG preferences
As a result of the second point, advisers will need access to ESG data and fund research to fulfil their requirements.
However, the amount and quality of ESG-related information reported by companies still vary considerably.
Furthermore, in the case of the fund manager, how ESG factors are implemented in the investment process can vary.
Having ESG in the fund title or mandate does not guarantee a robust process. Therefore, some reasonably detailed research will be needed before the adviser can recommend any ESG funds to their clients.
Several firms now provide research and ratings for funds based on their ESG characteristics and integration of ESG factors, such as the commitment across the manager’s firm to ESG issues or whether ESG views are translated into portfolio positions.
As with the general fund research described above, this can be quantitative; for example, aggregating company-level ESG data and scores for each fund and then normalising the totals to make them comparable across industry groups to derive an ESG rating for the fund.
Or it can be qualitative, where the fund manager and other key individuals are interviewed to ascertain their ESG approach, both at the firm and fund level.
Defaqto has been working on an ESG version of its Fund Reviews that will cover, among other things, the negative and positive screening carried out by the fund in terms of ESG, the fund management firm’s voting and engagement policies with corporates on ESG issues as well as some mention of the 3 P’s and the 3 R’s from an ESG point of view.
The information for all of this is obtained through a detailed meeting with the fund manager as well as sending them an ESG-related questionnaire to complete before the meeting.
We expect to launch these ESG Reviews early next year.
In conclusion, fund research can be both quantitative and qualitative.
