Knowing the difference between ethical, responsible and impact investing

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Royal London
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Supported by
Royal London
Knowing the difference between ethical, responsible and impact investing
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Climate change awareness and environmental concerns have never been more important, and over the past few years these issues have been spoken about in abundance when describing financial investments.

Three phrases in particular have been commonly used to describe investment products and strategies, but there is still confusion as to their exact meaning.

Mike Appleby, investment manager on the Liontrust Sustainable Investment team, outlined the difference between ethical investing, responsible practices and impact investing.

“Ethical investing looks to avoid controversial industries such as tobacco, arms, gambling, pornography, fossil fuels and big oil,” he says.

“Responsible investment typically refers to conventional funds that may avoid (small) areas of the market on sustainability grounds and possibly have some engagement with the management of companies in which they invest.

There are no clear definitions, and so when an adviser is looking for products for their clients, it’s really important to understand that there's a lot of fuzziness between these terms  Dan Kemp, Morningstar

“Impact investing describes an approach where investors want to own companies with meaningful positive impacts and that are able to quantify the benefits to society or the environment which they deliver.”

Dan Kemp, chief investment officer of Morningstar’s EMEA division, says it is worth remembering that there is a lot of crossover between these three terms.

“There are no clear definitions, and so when an adviser is looking for products for their clients, it’s really important to understand that there's a lot of fuzziness between these terms."

Kemp says the most important thing, especially for investing ethically, is to have a conversation with clients to work out how they define these terms.

“There is no universal ‘ethic’. Ethics are essentially personal values, and everyone has their own ethics and personal values.

“What you’re trying to do as an adviser is to align [a client’s] portfolio with their values.

“The first part of that is understanding what their values are – which is a really important conversation to have – knowing what their options are in terms of product selection, and then aligning the two.”

He says the major “sticking point” with advisers at the moment is that a lot are not comfortable with having that initial conversation.

“One of the reasons they're not comfortable having it is because they don't have a deep enough understanding of the products available, and I think that's a perfectly reasonable concern.”

He says that on the other hand, advisers can see this conversation as a form of progression in their relationship with the client.

“You’re having a conversation on a much deeper level about things that the client cares about. 

“So actually, it's a way of building a much deeper relationship with that client. It’s a wonderful conversation for an adviser to have [and] the feedback that we have from advisers that are actively engaging in having these conversations is incredibly positive. 

“It just feels like a big risk [for the] adviser to do it for the first time.”

Room for confusion

Declan McAndrew, head of investment research at Foster Denovo, adds that due to regulation running behind the pace of change that has occurred in this area, there is the potential for confusion and this leaves the door open for disparities in understanding and application.

“This may be inadvertent or more deliberate in nature,” he says. 

“It’s therefore vital that the first step for advisory firms and asset managers is to define and formalise their interpretation via a company-wide policy and then articulate this to clients in an accessible and constructive manner.”

Steve Kenny, chief distribution officer at Square Mile Research, agreed, saying that as there is currently no regulatory guidance on content or format of material, advisers need to do some groundwork to enable understanding.

“It is important to understand [clients’] preferences, but it needs to be recognised that these may not be apparent to either them or the adviser, and so open questions are key. 

“Perhaps you could start with asking them about how they interact with these themes in their daily lives, that is, the importance they place on recycling (circular economy investment theme), or if they have an electric car (energy transition investment theme).”

He says this helps to set the scene and provide more tangible context for what their investments could achieve.

Kenny adds that there might be help soon from the government.

“At present, it is a mishmash of material, however, the impending regulation outlined in the UK government’s recent roadmap, Greening Finance, will help create greater clarity for advisers and their clients,” he says.

McAndrew highlighted that the onus does fall on financial advisers to educate their clients around these issues.

“It’s clear that there is still some level of confusion from investors around the different forms of ESG, sustainable and impact investing. 

“However, it’s our role as advisers to educate clients around this – what the terms mean, what options are available, and how these differ.”

He says this means not just how these options differ between themselves, but also how they might be different to traditional non-ESG funds as well.

“Managing client expectations and authenticity of proposition are so important, as is transparency, among other elements.”

However, it is worth remembering that ESG, sustainable and ethical investing can have a positive impact on society. 

Appleby says: “Looking past all the different definitions linked to sustainable or ESG investment, which are often used interchangeably, what is really important is that sustainable aspects are analysed and used to help make better investments.

“Investing sustainably should be about making the world a safer, healthier, and more resilient place – as well as seeking strong returns.”

sally.hickey@ft.com