Investors are enlivened by the opportunity to marry up their social and investment goals. Product providers and advisers are keen to conduct the ceremony.
Yet where there is a gold rush there are cowboys. And in personal finance, where there are cowboys, there are regulators to protect investors from rogue agents.
In this case, ones promising to save the planet, while doing little more than painting their Stetsons green and claiming their spurs are ‘horse-friendly’.
Regulations need to provide enough guidance to be effective without becoming over-prescriptive. This is a difficult balance to find.
It is all too easy to unintentionally turn valuable investor protection into a toothless tick-box exercise, meeting the letter of the law, but failing to serve its spirit.
Moreover, and of particular relevance to environmental, social and governance issues, the harder it is for consumers to verify the promises they are trusting – looking at what the carbon emissions of this group of companies are and whether that is good or bad – the more likely that shortcuts will be taken.
For financial services companies, however, treating sustainability preferences as a tick-box exercise is a false economy.
Shortcuts in sustainable suitability that fail to meet real preferences or deliver real outcomes not only mislead investors but also lead the promoters of the greenwashed products somewhere they do not want to go: into regulatory trouble and dawn raids.
If it is ruled that an investor’s sustainability preferences must be ‘considered’, an investor stating, ‘Yes, I’d like some ESG’, and ending up with a token-gesture allocation to a fund that changed its name to include ‘green’ a couple of weeks before would tick the box, but it would be a stretch to call it either sustainable or suitable. It would meet the letter of the law, but it would be insulting the spirit of it.
If those charged with understanding investor preferences do so only superficially, history strongly suggests they are going to pay for it somewhere down the line.
The good news is that there need not be a trade-off between making suitable sustainable recommendations and making money: there is profit in the proper appreciation of investor preferences.
There are two main reasons for this, and they each spring from understanding that ESG opportunities are not only new things to invest in but a new way to see investing. ESG should be seen as less about shuffling assets around and more about engaging new groups of investors.
First, non-superficial approaches to sustainable investing will lead to cash being invested that would otherwise have stayed on the sidelines.
For many would-be investors, long-term risk-return statistics are a less compelling story without the emotional returns of also pursuing sustainable outcomes. At Oxford Risk, we have strong evidence that merely asking clients about ESG increases their engagement with investing as a whole.
Second, many potential investors see sustainable goals as a primary motivation, not as a nice-to-have, second-order add-on to investment concerns.
Traditional ESG marketing has, perhaps sometimes disingenuously, promoted sustainable solutions as a way to achieve social goals with no cost to financial outcomes.
However, responses to one of the core dimensions of Oxford Risk’s sustainability profiling tools – ‘Impact Trade-off’ – have consistently shown that a significant portion of investors will want to give up some financial returns or liquidity, or are happy to take more risk, if they know that their investments are likely to be having a social impact as a result.
Of the several thousand investors we have surveyed worldwide, 59 per cent agreed with the statement: "I would accept a lower financial return if an investment had social benefits."
Only 12 per cent disagreed. If you took your cues from ESG advertising, you would believe those numbers were the other way around.
At Oxford Risk, building on research covering many continents, and many thousands of investors, we have long argued that sustainability preferences are a key part of understanding financial personality – and therefore integral to a comprehensive suitability process – a process that understands that:
- financial returns are not the only thing investors value;
- financial returns are not just a means, they can be an end; and
- investors need to feel comfortable with their portfolio if they are to succeed.
It is always better to treat the patient than the disease. Sustainability preferences are part of a wider financial personality. Sustainable investments are part of a wider portfolio of investments. They are inevitably intertwined with questions of risk and other goals – both social and financial.
Prioritising matching ticks to boxes over investors to suitable solutions risks turning the best of intentions into the worst of outcomes, and profitable opportunities into regulatory fines.
Understanding and engaging investors on the dimensions that move them, on the other hand, leads to more money invested and more suitably, and sustainably so.
Greg B Davies is head of behavioural finance at Oxford Risk
