InvestmentsSep 9 2020

ETFs make ESG transparent

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Next year it will become mandatory for IFAs, under MiFiD II changes, to include questions on environmental, social and governance investing as part of their suitability process.

It should be a game-changer. 

However I am not yet convinced that many IFAs are ready for this change.

The compound effect of MiFiD, Prod and the SMCR changes has left many, despite their best efforts, struggling to keep up. They want to focus on their business, not more regulatory changes. The impact of Covid-19 has also proven to be an unwelcome distraction.

To date many have taken little or no action to prepare, but the MiFiD II changes cannot be ignored.

Inevitably panic will set in and we will soon see a huge increase in demand for clarity through marketing materials, better education on the topic and greater interest in the investable universe.

Fund Managers will be emailing out marketing materials. Any marginal out-performance from any fund claiming to be ESG-compliant will be held up as “proof” that they are the next big thing.

The invitations to ESG conferences will be coming in thick and fast (albeit many will be virtual).

But I fear there will be a huge gap between the specialists – those steeped in ESG history - and what the advisers can cope with right now.

We do not even have a common language around ESG within the IFA community to help differentiate between ethical investing, ESG investing and socially responsible investing let alone a long list of research analysts with a track record and skillset to properly evaluate ESG investment opportunities.

In trying to develop a common understanding, if not a common language, I try and explain ESG along the following lines: 

Ethical investing is where investors’ social and moral preferences are factored into the investment decision-making process.

To ensure there is a sufficiently broad investable universe these preferences have been extended to include ESG-related factors into investment decisions.

ESG factors include climate change policies, carbon footprints, recycling, ethical supply train sourcing, employee engagement and board level diversity.

ESG helps identify potential risks and opportunities beyond the traditional approach to valuation.

SRI goes one step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. SRI often relies on ESG to apply additional positive or negative screens into the investment universe.

The broadening of the investable universe has led to major changes in corporate behaviour, which is having a positive impact on investment performance. 

Funds investing in companies with strong ESG policies have, contrary to a widely held view, out-performed their benchmarks in recent years.