The asset management industry’s ‘full speed ahead’ approach to providing environmental, social and governance investing has left advisers with a “minefield” of ratings, due diligence and fact-finding potholes to navigate.
ESG investing has boomed in popularity over recent years as fears over climate change have led investors to consider the impact of their money and as a growing number of millennials have begun investing.
Morningstar’s latest report showed assets held in ESG funds worldwide hit a record £810tn in June this year as investors pumped £54bn into sustainable products in Q2 alone.
Fund houses have been quick to respond to the ongoing trend with numerous fund launches.
The problem
But the complex nature of a client’s ESG choices, the sometimes contradictory and flawed rating systems and fears of ‘greenwashing’ have created a confusing and challenging maze for advisers, experts have warned.
The recent Boohoo scandal was a prime example of the issue – the fast-fashion retailer was given an AA rating by MSCI for above-average labour standards just weeks before The Sunday Times reported in early June workers making its clothes were paid below minimum wage and suffered poor working conditions.
Boohoo has since announced an independent review of its supply chain, though it has said there were inaccuracies in the reporting that made the allegations.
It has since emerged 20 ESG funds had invested in Boohoo. These included Aberdeen Standard’s UK Ethical Equity and UK Impact Employment Opportunities Equity funds, which held it as its largest single holding.
Manager Lesley Duncan said she had engaged with Boohoo about its ESG performance over a period of years and felt progress was being made, but she concluded the company’s response to the recent allegations was “inadequate in scope, timeliness and gravity” and her funds sold their holdings in Boohoo in early July.
Boohoo was also held by the Premier Ethical fund, which has also sold its position since the allegations emerged.
Steve Nelson, insight director at the Lang Cat, said: “It is a minefield for advisers.
“What financial services is adept at is getting very quickly into ‘manufacturing mode’ and before you know it we have lots of ESG funds and risk ratings when it is clear the notion of what exactly ESG is isn’t mature enough yet or fully defined.”
He said there was a series of processes available that “spit out a rating” that just “would not pass the sniff test of a human being”.
Mikkel Bates, regulatory manager at FE Fundinfo, agreed. He said: “You cannot expect investors or even advisers to have a clue what the difference is between the ratings, or keep up with company changes.
“It’s not easy at all as there are several aspects to the question – the client’s values, what the regulator expects, how the asset manager behaves. ”
What to do
Advisers have been urged to delve into their clients’ ESG preferences thoroughly to ensure the fund matches their values.
Clive Waller, managing director of CWC Research, said: “The adviser should ensure they discover what the client wants. It could be ethical, thematic, sustainable or ESG.
“This may be painstaking, as a client may wish to invest in companies that do good. This is subjective. For example, medical protective equipment is made from plastic, largely, which comes from oil.”
Mr Waller urged “good IFAs” to develop a proposition and to research providers who could fulfil it.
David Boyhan, a consultant at compliance firm TCC, agreed. He said: “Having a client tick a box to say they are interested in ESG funds won’t tell the full story. There needs to be a conversation about why the client is attracted to these funds.”
Meanwhile Darius McDermott, managing director of FundCalibre, said funds that provide their own ESG analysis were a safer bet as third-party data providers were “backwards looking and had notable gaps”.
He added: “Good fund due diligence should involve understanding the criteria of an ethical fund and the process taken to get there, cross referenced with the portfolio to identify any contradictions”.
A report by wealth manager SCM Direct, published in November last year, revealed there was a low correlation between different ESG scores.
For example, Tesla is ranked by MSCI at the top of the industry on ESG issues while FTSE brands it as the worst carmaker globally. Sustainalytics puts the company in the mid-table.
According to the report, MSCI had given Tesla a near-perfect score due to its clean technology, while FTSE ranked it low as it only rated the emissions from its factories.
Hortense Bioy, sustainability research director at Morningstar, said there was “no shortcut to proper due diligence when selecting an ESG fund”.
She added: “This is where ESG allocation funds can come in handy. Multi-asset fund managers can apply consistent exclusions policies and consistent ESG incorporation strategies across the whole portfolio.”
But Mr Nelson urged advisers to look to specialists for help.
He said advice companies’ centralised investment propositions were often not compatible for clients with stringent ESG principles, so outsourcing was the “safest way” to deal with bespoke needs and requirements.
imogen.tew@ft.com
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