ESG: The rub of the green

17 July 2019

The more asset managers that incorporate environmental, social and governance thinking into their investment philosophy, the more traction ESG investing will enjoy.

This article was originally published in the Multi-Asset Review.

Fraser Donaldson, Insight Consultant (Funds & DFM)

Environmental', ‘green' (‘light' and ‘dark' and all shades in between), ‘SRI', ‘ecology', ‘responsible', ‘renewable', ‘negative screening', ‘positive screening', ‘engagement' - these are all terms the world of retail finance has, rightly or wrongly, associated with the generic term of ‘ethical' investing. Every five years or so, it seems, there has been a big push on this area in its various guises.

Around those sorts of time, I will usually be asked for articles on the subject and, being of a particular vintage, that has made for quite a few articles. Their gist, however, is always the same: ‘Good idea but there are only a small percentage of people investing to make money for the future who are prepared to stand by their principles and restrict their investment universe.'

And that has always been borne out by the figures - for as many years as I can access, the Investment Association shows ethical investment pretty much stationary in percentage terms at around 2%.

Only last year I wrote a piece, expressing similar sentiments to all the others I had written, but I did have a suspicion the asset management industry was warming to the idea that investments made in a ‘responsible way' may have an advantage.

I finished off the article expressing the following thought: "‘Perhaps in another 20 years' time, when all companies are run in an ethical, socially responsible manner, I will be woken from my afternoon doze and asked the question, ‘Grandad, we learned about ethical funds in history at school today. Why did we need them?' I will then tell the story and their mouths will fall open in disbelief. You can live in hope!"

So, some 35 years after I first talked to ethical fund managers - then treated as oddities - the asset management sector is beginning to acknowledge these pioneers, who were ‘doing the right thing' rather than going for the ‘fast buck', were right all along. Further, if they were unable to invest in companies doing the right thing, they would use their influence as shareholders to encourage the companies to change practices.

So what has changed? On the face of it, ‘Ethical' has had a rebrand so that all the talk is now about ‘ESG'. Just another acronym, then? Ethical by any other name? Well, not quite.

‘ESG' stands for ‘environmental, social and governance'. Relatively new to the retail investment arena, it can best be described as an investment philosophy that believes companies that operate under strong ESG principles may well be giving themselves a better chance of a much healthier long-term future with fewer risks and potential controversies - sustainability, in other words. Yes, it still sounds a little bit like ‘ethical' investing - and certainly that is part of it.

The last couple of months has seen a rush to market of a number of ESG portfolios in the discretionary world and, valuable as these additional choices are, this is not what I believe is going to give this investment approach traction and raise it above the level of a cyclical investment fad.

Some institutions have, for a number of years, been operating all their investments under ESG principles. For some, it has already become the norm and, if you look hard enough, you will find ESG statements on the websites of some asset managers - although at present they are rather few and far between. These asset managers believe companies that operate this way will have a better chance of a healthier and more profitable long-term future and, because of this, become a more attractive investment opportunity.

Becoming the norm

For some asset managers, then, ESG analysis has become the norm, not the exception. The more companies that incorporate this approach into their investment philosophy, the more traction ESG investing will enjoy. While launching a few ESG portfolios among a much larger range can offer advisers and clients some valuable additional choice, it does still gives the perception of something unusual and therefore more difficult to 
buy into.

We are aware of a number of working parties in Europe and the UK that are looking at standardising ESG analysis, and the regulators certainly feel it is an area that should not be ignored by advisers when selecting investments and talking to their clients. Again, this is what will give ESG investing traction.

While I can see some irony in ESG investing taking off because it is viewed by some asset managers as a genuine contribution to selecting more profitable companies over the longer term, rather than a burning desire to do the right thing, I am still content as it is undoubtedly the right direction of travel.

I have now abandoned the cynicism of earlier articles and believe ESG investing will become much more mainstream over the next couple of years and it will be my children, rather than grandchildren, who will not have to worry about investing in "evil" big business that is ruining the planet.

Asset managers take note - those are their words, not mine.

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