The evolution of ESG terminology

The asset class began with the creation of ethical mandates, which sought only to exclude those companies that do not conform to the principles.

But in recent years, the evolution has continued, with products created that now allow clients to invest in specific themes, such as renewable energy, or on the basis of the positive impact those companies have on the world, as well as funds that take a responsible approach to investing.

Chris Iggo, chief investment officer, core investments at Axa Investment Managers, describes the different terminologies as “a nightmare”. 

He says: “We are very early in the evolution and there is no standardisation. At Axa we have gone through several iterations of what we call things and part of the reason for that is the regulations are becoming more specific, especially in Europe.

"I think the difference really between the different products that come to market is that some are products which do ESG and some are about the process of how they invest, but this is recognised in the European regulations.

"An Article 6 fund, for example, is a standard fund that may take ESG factors into account, but does not have a target, an Article 8 fund is one that is more advanced and which will have ESG scores and in aggregate will aim to have a better ESG score than other funds in its universe.

"And an Article 9 fund is one that has very clearly defined key performance indicators, which are often linked to the UN sustainable development goals. These regulations are not in the UK yet, but they may be in future.” 

Sarah Norris, investment director at Aberdeen Standard Investments (rebranding as Abrdn in the summer), says the differences in terminology is enabling some of the “greenwashing” she sees in the industry, as market participants rush to label products in line with where the latest market trends are as a way to attract fresh flows. 

Unlike Iggo, she says she believes that those who simply integrate ESG into their process, rather than have a dedicated ESG remit, may be guilty of this.

She says: “Those who say they have ESG integrated into the process of investing, well, all fund managers should be doing that anyway, as that is part of assessing the investment case.”

Andrew Parry, head of sustainable investing at Newton Investment Management, says the evolution of terms is “a natural part of the coming of age of the asset class, in the same way as there are many different types of UK equity funds or US equity funds”.

He says the first rule for any company – whatever label is applied – is that they survive as a business, something which proves the business to be sustainable. 

Helping provide clarity

Shaunak Mazumder, who runs the Future World Global Equity Focus fund at Legal & General Investment Management, says the increase in the number of types of ESG funds has been met by an increase in the number of ratings agencies assessing products, and the services of such agencies can help to provide clarity. 

He says the UN has published a range of SDGs, and a client can understand what the priorities of a fund are by seeing which of these goals the fund focuses on.

Sebastian Thevoux-Chabuel, ESG analyst and portfolio manager at Comgest, says some types of investment products will find it much more difficult to invest in line with ESG principles.

He says hedge funds have a mentality that is too short-term, while the popularity of ESG strategies right now means that lots of capital is chasing the assets, which makes it more difficult for value investors to operate. 

He added that value investors tend to focus “on the numbers” so the more thematic approach that is part of ESG is not their natural habitat. 

Angus Parker, who runs the HSBC Global Equity Climate Change fund, says the different terminologies used reflect different “levels of ambition” that providers have. 

He says: “There is a spectrum of approaches that reflects degrees of ambition and objectives ranging from “do no harm” via thematics, to explicit positive impact funds. Having understood what the end client really wants, the adviser must feel comfortable with the product being offered.

"The portfolio manager must be able to explain what they are doing and why – preferably with some academic research to substantiate their approach. Subsequent portfolio actions made by the manager must then be demonstrably consistent with the investment approach articulated. Finally, independent third-party validation can help demonstrate that the fund is doing what it says it is doing.”

Maria Municci, fund manager on the multi-asset ESG team at M&G, says that in addition to regulatory and ratings agency information, “a detailed ESG/sustainability policy published by the fund manager could be a useful document for investors, providing information on the non-financial objectives, the responsible investment approach adopted to achieve them, and the criteria used to implement it (such as carbon footprint, alignment with UN SGDs, minimum ESG thresholds etc).

"While sustainable investing continues to evolve, transparency and communication regarding the fund’s criteria, approach and expected outcomes is crucial.

"For example, for our sustainable multi-asset strategies we publish a document describing our ESG and impact criteria as well as an annual report with details on the sustainable characteristics of our holdings and overall portfolios."

Regulatory changes

Paul Niven, head of multi-asset portfolio management at BMO Global Asset Management, says: "Regulatory changes will soon mean that advisers must ask about responsible investment preferences as part of the know-your-client process. The demand for ESG-related solutions has increased significantly and that’s a trend we see continuing.

"Several things provide impetus for that shift. Regulation is key but there’s also greater recognition that investing responsibly makes financial sense as ESG risks can have a material impact on returns. Also, individuals are more aware of the challenges the world faces and are keen to do their bit through investment choices – avoiding investing in polluting companies for example.

"At BMO, responsible investment sits at the centre of everything we do. Consideration of ESG risks is integrated into our investment processes and we’re aware that sustainability related mega-trends, such as a transition away from fossil fuels, provide some interesting investment opportunities."

Niven adds: "From a multi-asset perspective, it’s important to apply consistent parameters across all asset classes – we operate within the same ‘avoid, invest, improve’ ethos."

David Thorpe is special projects editor at FTAdviser