Using transitioning companies to promote sustainability goals

And where someone is looking to retire in, 20, 30 or even 40 years' time their adviser might look to employ a different approach depending on the length of time they want to invest for.

Dominic James Murray, director at Cameron James, says any client, irrelevant of their age, who has a 30 to 40-year investment time horizon, should be taking on a far greater level of risk if they are comfortable to do so.

He explains: “There will likely be numerous financial crashes and recessions over a 30 to 40-year period, and as such, the client has sufficient time to weather the storms.

“Clients with an investment timeline of up to 10 years can obviously still take risk, but they have to be aware of the possibility for a market correction during those 10-years and how it may affect their portfolio value.”

Kate Capocci, co-manager of the sustainable managed portfolio service at Tilney Smith & Williamson, says: “When choosing a fund it’s important to understand the process, philosophy and investment team.  

“They have control over the underlying stocks, so you want to have a solid process that also matches your own values and a team that you can trust.”

Regulation of ESG

The awareness that clients have about ESG investments is likely to accelerate further as regulation catches up.

Created to develop consistent climate-related financial risk disclosures to be used by companies, banks and investors, the Task Force on Climate-Related Financial Disclosures is an existing global voluntary framework created in 2015 by the Financial Stability Board to increase the amount of information and transparency at the business and investment level, giving investors and others the ability to assess, and price, climate-related risk and opportunities.

As reported by FTAdviser, rather than creating a new regulatory framework, the Financial Conduct Authority has selected to adopt and provide flexibility around an already existing and widely accepted international framework. The hope is that this will allow businesses to better integrate the new rules with any current existing ESG frameworks they may be reporting under. 

 When choosing a fund it’s important to understand the process, philosophy and investment team.Kate Capocci

The FCA began implementation of the TCFD recommendations on January 1 2022 for asset managers with assets under management greater than £50bn, with a publication deadline on the June 30 2023. The second phase will be effective from January 1 2023 for remaining asset managers with AUM greater than £5bn, with a publication deadline of June 30 2024.

Currently, the different types of investing principles that fall under the ESG banner means that different strategies will achieve different objectives for clients.

Socially responsible investment generally focuses on excluding sin stocks from the investment pool based on negative screening guidelines.

Thematic investing is unconstrained by traditional geographic and sector demarcations focusing instead on top-down systemic shifts.

Impact investing positively screens candidates on their ability to generate favourable influence on society and the environment, to minimise any detriment and generate positive returns.

Transitioning companies

According to Capocci, one area an adviser can add value to a portfolio is by talking to their clients about investing in transitioning companies.

Transitioning companies are businesses that are not considered thoroughly compliant with ESG principles but are making efforts to get there.

Energy company RWE is a great example, Capocci explains. “The company often cannot be held in more thematic sustainable portfolios or exclusionary portfolios because of the legacy holdings in thermal coal.  

“However, they are growing their renewables exposure and are already a leader in the space, but trade at a steep discount to pure-play peers like Orsted. Orsted itself followed this same path (originally call Dong – Danish Oil and Gas) and now attracts a higher premium now it has completed the transition.

“By investing in transitioning companies, supporting them with capital and actively engaging with management to encourage the transition, investors are more able to create positive change than simply investing in stocks that have already gone on the journey.”

 All you need to do is read the brochure of any major oil company and you would think that they are the most environmentally friendly company on the planet, which is arguably not true.Dominic James Murray

Jean-Paul Grenade, head of investment specialist sales at Aviva, says when it comes to transitioning companies it is important to understand what a company is trying to achieve and how they are going about achieving it. 

“Looking at the longevity of the company itself can also be beneficial,” he adds. 

“For example, companies that once set out as purely oil extraction firms have, over recent years, chosen to see themselves as energy companies – as opposed to oil companies – and are now investing heavily in renewables, which is great news. 

“These are firms that can have a huge impact in reducing their carbon footprint and are also focusing investment in the right places. These firms are very much on the journey to enhancing their climate credentials.”

ESG screening

For James Murray, this is a problematic area: trying to decipher between fact and fiction.

He says: “All you need to do is read the company brochure of any major oil company in the world and you would think, from that brochure alone, that they are the most environmentally friendly companies on the planet, which is arguably not necessarily true." 

This is why screening is so important.

ESG screening is a way of mitigating risk and aligning funds with an investor's objectives and ethical motivations, as defined by a note on the Morningstar website. It also brings an important level of transparency and makes it easier to compare funds with their peers.

 Ensuring that asset managers' actions are aligned to customer values is the most important part of the adviser journey.Jean-Paul Grenade

Grenade says it is important that the fund manager understands the investment rationale and purpose of every stock in the portfolio from an ESG perspective. Meanwhile from an adviser’s perspective, it makes sense to avoid stocks where their business has a negative impact on human capital or the climate.  

It is also important, he adds, to understand what companies are doing to enhance working conditions for their employees: “For example, firms which make medicine are naturally helping the human capital element, and it is great if they also promote diversity – particularly because diverse firms tend to perform better. However, those which employ exploitative labour conditions should clearly be avoided.

“It is important that advisers have tools that help them understand what a firm does and how it does it. However, ensuring that asset managers' actions are aligned to customer values is the most important part of the adviser journey.”

ESG integration is a core risk assessment tool, defined by the UN principles of responsible investment as “the systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions”. 

 By investing in transitioning companies investors are more able to create positive change.Kate Capocci

It is a way to incorporate responsible investment into investment decisions, alongside thematic investing and screening.

Capocci says as ESG data is so patchy, investors and advisers ideally want an active manager who can scrutinise the information available and engage with the companies held. 

“ESG data is so patchy, in terms of quality and consistency, that I am always wary of systematic screening processes,” she says.

“Screening is a blunt tool, but if you have specific values and areas you just don’t want your money involved in then it is the only way to go.”

ima.jacksonobot@ft.com