Understanding the ESG investment universe

Understanding the ESG investment universe

The waves of new interest in environmental, social and governance funds have created fresh opportunities for advisers.

However, it also presents the challenge of aligning the clients' needs and aspirations with the products that are on the market. 

While there has been an increase in the number of investment products aimed at clients with an ESG focus, there has also been a proliferation in the number of terms used to describe those products and portfolios, ranging from 'ethical', 'sustainable' and 'responsible' to 'positive impact'. 

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Each of those terms describes funds or portfolios that are within the ESG universe, but all seek to do slightly different things – the problem is, there is no standard definition for any of those terms. 

Adding to the dilemma are those funds and portfolios that claim to have ESG considerations 'integrated' within them, without clearly defining what that means.

The range and variety of meaning an adviser must navigate when building exposure to ESG funds is like a “jungle”, says Ladislas Smia, co-head of responsible investment research at specialist asset management business Mirova. 

He says one can generally divide ESG product providers into two groups: some companies regard ESG as just one more factor to consider when looking at the investment case for an asset, while others regard ESG credentials as both a part of the investment case and with regard to the impact of those products on wider society.  

Mr Smia says: “Generally speaking, there are ESG product providers whose sole focus is on the financial risk – which is called materiality – of a company, that is, how its ESG policies might impact a company’s financial performance.

"The other group is companies that, of course, have materiality as one of the considerations, but also give consideration to non-financial factors as well.” 

The second group includes funds that would describe themselves as sustainable, responsible or positive impact funds. 

He said some clients are likely to be content with a focus on simple financial materiality, while others want the 'double materiality', which considers both the financial impact and the societal impact of a company’s activities. 

Emily Kreps, global director for capital markets at not for profit ESG platform CDP, says one way to speak with clients about ESG is to use the analogy of the “responsible parent”.

She notes this is an analogy that explains the permanently subjective nature of ESG investing. 

She says: “People will have somewhat different views about what being responsible as a parent means, and people have different views about the ways to achieve that.

"That’s why I don’t think we will ever have standard definitions for ESG investing, just as we don’t have standard definitions for what is a responsible parent."