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'.
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.
The range and variety of meaning an adviser must navigate when building exposure to ESG funds is like a jungle Ladislas Smia, MirovaAdding 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."
Ms Kreps adds: "When it comes to responsible investing, the key really is the journey the company is on – are they transitioning to being a responsible company? So, I think the key is to step away from the buzzwords and to focus on what the end client wants.
"From there, the key is transparency from the companies involved. The next big development in the responsible investing area is likely to be around the financing of projects, so the providers of the capital, rather than just the companies that use the capital in a way that is not ESG compliant, would be excluded from responsible investment funds."
This could have implications for banks or asset managers who finance projects, where the projects themselves are not ESG compliant. That could lead to the exclusion from ESG indices of those providers of capital, and so suffer in share price terms.
Sandra Crowl, stewardship director at fund house Carmignac, says that many new entrants into the ESG market may be “unintentionally” greenwashing – that is, investing in a way that may run contrary to ESG principles while being marketed as an ESG-compliant product.
She says many such companies may not have the experience required to properly understand the themes at the level required. She adds that standard definitions would help clients understand the products offered by various providers in a better way.
Andrew Parry, head of sustainable investing at Newton Investment Management, says each client’s requirement from a sustainable investment fund is different, but that ESG as a term is useful to describe the methodology used to achieve the outcome, rather than the outcome itself.
He says: “Every client has a different need and a different definition of what they want, whether that be sustainable investing, responsible investing or impact investing.
"My definitions of all of those might differ to those of a client, but ESG is the input we use to get the output, which is the thing the client wants. The concerns and priorities that clients have definitely change, but ESG is the framework for achieving those aims as they change."
Mr Parry says standard definitions being imposed may not help client understanding, due to the subjective nature of each client’s requirements, and this means he sees relatively little value in having a set of standardised definitions as those would be just as subjective as it would be if he, as a fund manager, created the definitions.
He says that while he has his own view on the type of investments that qualify as ESG, his is only one view.
Evidence based
John Fleetwood, director of responsible and sustainable investing at Square Mile Investment Consulting & Research, says the division he sees between providers is that some “integrate ESG considerations into the funds they are running and view it as part of the wider investment process, it is one consideration among many, while others are dedicated ESG funds with a remit to invest in a certain way”.
He adds: “Sustainable funds are looking for evidence that the company's outputs are not harmful, while responsible investing funds are looking at the company's operations, at how the outputs are achieved. More recently, we have seen a rise in adviser interest in impact funds, that is, funds that make a positive impact on society. I do think an agreed set of definitions would be very useful.”
Mr Fleetwood says the first task for a fund selector is to understand which of the above alternatives applies to the fund they are looking at for clients.
Joachim Klement, analyst at investment bank Liberum, says he finds the present proliferation of ESG fund ratings not particularly useful to him, but says the biggest challenge faced by fund buyers in the ESG space is disclosure around their process, and he is not sure that standardising definitions will help.
Steven Desmyter, co-head of responsible investing at Man Group, says there are ways an adviser can understand the true intentions of a fund provider.
He says: “Understand the workings of the EU Sustainable Finance Disclosure Regulation. This provides a comprehensive template for responsible investment and is the blueprint that all managers ought to be working towards.
"One key distinction is between Article 8 funds, those where sustainability is one of a broad range of investment goals, and Article 9 funds, where the ESG mandate is the driving impulse behind investment decisions.
"You need to concentrate as much as possible on evaluating objective criteria to ensure the fund is fulfilling its responsible investing mandate. The best guard against greenwashing is to ensure the manager is doing what they claim to do."
Mr Desmyter adds: "Even though many ESG measures are subjective, you must hone in on the objective measures: carbon emissions and commitments, gender and racial diversity, board independence. Ensure that the targets are both ambitious and credible and then establish the extent to which the fund is meeting them.”
Miranda Beacham, head of ESG in the equities and multi-asset group at Aegon Asset Management, says a problem with standardisation is that one would not be comparing like-for-like.
She says: “Trying to compare ESG funds that have different focuses is of limited use and rather like comparing apples with oranges.
"For example, a fund focusing on innovative healthcare is likely to have a smaller carbon footprint than one focused on the transition to cleaner energy and transport.
"This does not make the latter ‘worse’ from an ESG perspective, or any less deserving of capital. It is simply a result of the fact that it is focusing on different sustainability challenges."
Ms Beacham adds: "If we are to address the many significant challenges that face the world today, we will need a range of approaches.”
David Thorpe is special projects editor of FTAdviser
