How to think about sustainable investing for the long term

For Kate Elliot, head of ethical, sustainable and impact research at Rathbone Greenbank Investments, the regulatory outlook for providers is unlikely to look radically different to the sustainable finance disclosure regulation deployed in EU countries. 

The UK government is presently consulting on its own proposals, and while Elliot does not expect it to differ much from the EU legislation, she does expect the requirements placed on advisers to change further, with an increased obligation to ask clients about their sustainability preferences, rather than wait for the client to ask.

She says: “Many clients don’t like to bring it up, so a change that further requires the adviser to start the conversation will have an impact on the market. We may also see some clarity around the definitions, around what is a sustainable fund compared to an impact fund etc. But that taxonomy, that should be the floor, the minimum in terms of what sustainable investment products are trying to achieve.”

Regulatory proposals

Clive Emery, multi-asset fund manager at Invesco, sits on a number of industry boards and working groups examining the regulatory outlook.

He says: “I have contributed to work by both the Treasury and the Financial Conduct Authority on this topic. I think what you will see in the years ahead is that the skillset of sustainable investment professionals will broaden as the market grows. The key question being asked right now is whether the new regulatory framework in the UK should be rules based or principles based.

"I favour making it principles based because I think the whole sector is very broad, and there will be different types of funds coming to market. The key is that providers present their offerings honestly, and let the end client decide if they are sustainable. In that way, the properly sustainable ones will ultimately succeed.” 

 ESG taxonomy should be the floor, the minimum in terms of what sustainable investment products are trying to achieve.Kate Elliot

Kate Rogers, head of sustainability at Cazenove Capital, says: “Transparency is key to assessing how sustainable a multi-asset fund really is. Sustainable funds should avoid harm and have a significant allocation in assets that are contributing to building a sustainable future. Just like financial metrics are key to appraising the financial performance of a multi-asset fund, impact metrics are important to assess the sustainable performance. 

"A sustainable fund should demonstrate alignment to a net zero transition path and demonstrate how the companies within the portfolio generate positive impact." 

Eren Osman, co-chief investment officer at Arbuthnot Latham, says one of the major issues to be dealt with is the levels of reporting carried out by sustainable funds. He says this varies widely and that regulators should look to develop a standard level of reporting. 

The second challenge facing advisers looking to the future of sustainable funds is to examine how client priorities may change in future. For example, the war in Ukraine may have changed some clients' perspectives on the ethics of investing in arms companies. 

Elliot says that at Rathbone Greenbank they use a combination “of the feedback we get from clients and also the daily news flow. We monitor that very closely to see what is coming up, and what the latest trends are. We have more than 300 sub-criteria that feed into our process and we can always add to those, or tweak how much priority we give to each one”. 

ESG frameworks

Ben Palmer, head of responsible investing at Brooks Macdonald, says: "Regulators around the world are developing frameworks to provide more structure and consistency in the ESG and sustainable investment markets.

"The EU has already implemented the SFDR regime, which provides guidance on the sorts of business activities that can be defined as ‘sustainable’ as well as a fund labelling system, which is intended to help investors understand the degree of ESG integration and focus. The UK is implementing a similar regime under its sustainability disclosure requirements proposals.

"It is difficult to say what the exact implications of this will be as the details, including the proposed product labelling requirements, are still under consultation.

"However it is clear that this will be a big focus for the FCA and multi-asset portfolios that currently define themselves as being ‘sustainable’ will need to assess their processes, underlying holdings, and reporting against the new framework to determine if they meet the SDRs' more prescriptive requirements within the new labelling system.

"We should know more later this year. More broadly speaking the move to align investment portfolios to a net zero pathway will have implications for the whole investment industry, whether sustainability-focused or not, making the assessment of an underlying investments transition to a net zero world a key part of analysis." 

The key is that providers present their offerings honestly, and let the end client decide if they are sustainable. In that way, the properly sustainable ones will ultimately succeed.Clive Emery

Palmer adds: “The above developments are designed to help in this endeavour, however we do not believe that advisers or any investor should solely rely on a product label. The world's sustainability challenges and the investment approaches that are developed to help address them are broad, multi-faceted and nuanced, with robust debate around what constitutes best practice.

"This is not necessarily a bad thing but it does make simple comparisons challenging. There is a temptation to fall back on ESG data scores, whether they are specific like carbon intensity, or broader like an MSCI or Sustainalytics ESG risk score. These scores can have their uses as part of a more holistic assessment of a fund however they do not necessarily give you the full picture and only provide a snapshot in time."

In terms of long-term asset allocation, Osman says that because few alternative assets are available to investors in the sustainable universe, over the long term investors are bound to have more in bonds than would be the case in non-sustainable portfolios, many of which have reduced bond allocations in recent years as a result of low yields. 

Osman says he does not expect the long-term asset allocation to be altered significantly as the sector evolves. 

david.thorpe@ft.com