Understanding what your client means by 'ESG'

During a speech last year at a Make My Money Matter event, Carney said that pension funds realised that addressing climate change was in their interest as climate risk is investment risk, and pension funds would need to provide answers for when people asked whether their money was being invested in line with their values – for example, in line with the transition to net zero.

Yet, currently, many people do not seem to be aware they can make active choices regarding their pension investments, or they are choosing not to make them.

According to data from The Pensions Regulator, in 2020 95 per cent of clients remained inside the default strategy or funds of their UK pension schemes, up from 90 per cent in 2019.

Defaults vs Sipps

Dominic James Murray, director at Cameron James, says this is one of the biggest problems with the UK pension industry, where very few clients have an active relationship with their money.

He says: “I do not believe that the UK asset managers or trustees want clients to have an active relationship with their pension money. It is easier for them and also allows them to place clients in default strategies, which are typically more expensive and profitable for them than if the client was involved and bought funds themselves individually. 

“For example, you may have an XYZ pension scheme balanced portfolio at 0.75 per cent a year, which does not sound expensive or unreasonable to a layman client. 

“However, this portfolio has often simply been white labelled and the real cost of his portfolio is maybe 0.10 per cent – 0.40 per cent a year. This is a huge mark-up, and can negatively affect a client's long-term portfolio performance.”

This is why a self-invested pension plan is more suitable for those saving for their pension because of the flexibility and autonomy it brings, James Murray notes.

 Ignore all the jargon and try to understand what the client is most interested in.Kate Capocci

“The majority of clients would be far better suited with a Sipp, which would allow them to have full investment freedom and choice, and choose some of the best-performing and lowest cost funds available in the market, including access to environmental, social and governance funds,” he adds.

“A Sipp can be managed individually by a client, if they feel like they have the confidence to do so, alternatively, they can contact an independent financial adviser to help them manage the Sipp.”

Kate Capocci, co-manager of the sustainable managed portfolio service at Tilney Smith & Williamson, agrees: “Most people can make active choices about their pensions. With standard workplace pensions you can often ask for your funds to be managed in one of the sustainable strategies. There is, of course, more flexibility in structures like Sipps to further define how you want your portfolio to be managed.”

Understanding ESG

While clients will be asking more questions of their funds, invariably, they will also be interested in how well ESG funds perform.

But there could be a challenge in trying to understand and explain how well ESG funds perform when there are so many fund strategies under the ESG banner that do different things.

ESG funds have attracted a huge amount of media attention over the past five years, but there is a lack of standardised definitions. What one business believes to be qualified as an ESG company or ESG fund may not be the same as another. 

 I do not believe that the UK asset managers or trustees want clients to have an active relationship with their pension money.Dominic James Murray

According to James Murray, this potentially leads to a huge amount of manipulation inside the ESG market, mainly for marketing purposes rather than for sustainability purposes.

And it is not just understanding the different definitions that matter when it comes to performance, but also understanding why a particular ESG fund performs in the way that it does.

Rick Eling, head of adviser propositions at Quilter, says advisers risk “tripping over themselves” if they do not understand the performance impact of a sustainable bias to a portfolio.

He adds: “Unfortunately there are a lot of advisers who think, wrongly, that the way to select a fund is to look at three years and pick the one with the best track record. That’s a disaster for clients and a disaster not just in responsible space but in all advice.

 We believe regulatory developments will become more important as efforts are made to bolster confidence in the world of ESG investing.Maria Nazarova-Doyle

“Broadly speaking, if you have a sustainable bias, you are going to carry a growth equity bias, as opposed to a value equity bias. On balance there are more companies in the growth tech sector that are likely to have and be suitable for a sustainable portfolio than there are on the value side.

“What that means is when growth equities have a run, these portfolios are going to do well. The problem is when advisers mistakenly believe that means they will always outperform because the managers are better. This is a broader point about how advisers can frequently misinterpret what is driving the performance of a fund and over-attribute performance to manager skill, which is repeatable versus things like style bias, which is not necessarily repeatable.”

To help tackle this challenge, Capocci says it is better to think outside these ESG, responsible, ethical or sustainable terms when thinking about a client’s suitability preferences.

“Ignore all this jargon and try to understand what the client is most interested in,” she says.  

“Do they have any hard lines (eg armaments, tobacco) or do they have an interest in specific themes (eg renewables). It is easier to use this information to find solutions."  

She adds: “Be open, honest and realistic about what you can offer. Multiple exclusions are difficult to manage in a direct portfolio and almost impossible to manage when investing solely through funds.

"When speaking to clients, try to remove jargon from the conversation and just understand what they mean by responsible/sustainable/ethical and build from there."

Maria Nazarova-Doyle, head of pension and responsible investments at Scottish Widows, says: "As investors have shown increased interest in and demand for investment products that take ESG opportunities and risks into account, asset managers have developed new products, and refocused and rebranded existing offerings in order to provide a broad category of ESG-related funds. 

"We believe regulatory developments will become more important as efforts are made to bolster confidence in the world of ESG investing. The Financial Conduct Authority aims to build transparency and enhance trust in ESG products and, as the growth in the market continues, it believes there is risk of investors receiving detrimental advice or unsuitable products.

"It is considering if information such as providing the sustainable objectives of certain investment products could help consumers make better-informed choices, [as well as] certain disclosure requirements, including asset managers to report on their sustainability risks, opportunities, and impact."

ima.jacksonobot@ft.com