By Tribe Impact Capital
The announcement of the UK’s proposed Sustainability Disclosure Requirements (SDR), followed by the recent release of the Roadmap for Sustainable Investing, is the latest indication that sustainability will continue to be central to the world of financial advice.
For financial advisers, as the SDR are implemented, there’s an enormous opportunity to better service clients. The challenges financial advisers face trying to interpret and verify sustainability information from asset managers and other product providers should significantly reduce as improvements are made in the disclosures and product information provided by asset managers.
Financial advisers will also play their part in the delivery of the Roadmap. There’s arguably never been a better time to appreciate the differences between ESG and impact investing and their effect on your advice processes.
The growth in ESG compliant funds appears to be inexorable. As we’ve mentioned before1, ESG labelling continues to be problematic for two main reasons. Firstly, due to the inconsistent definition and application of ESG principles.
Secondly, as a result of a reliance on third-party collected data, which in itself doesn’t go far enough in redirecting capital in public markets to where it’s most urgently needed to solve the environmental and social problems we face as a society. It’s important investors are aware of the limitations of fund labels, in ESG or indeed sustainability.
There’s a significant commercial opportunity in ESG and the fund management industry is responding. Recently, Bloomberg estimated that within five years ESG funds will make up one third of the projected $140.5 trillion global total by 2025; and that ESG assets are on track to reach $53 trillion – up from $37.8 trillion – by year end2.
As part of this expansion drive, many existing funds have been re-labelled. In the UK in 2020, there were 505 sustainable funds launched, while 250 were simply repurposed existing funds that had previously not marketed themselves as having any sustainable credentials3. With such growth, and the re-tooling of investment teams required to incorporate ESG analysis, there is a danger of variations in quality.
Our experience with our fund due diligence has revealed a noticeable divergence of quality within these launches. Since inception, we’ve done extensive due diligence on more than 150 varying funds across all asset classes (all of which market themselves as either ESG or impact) and only around 40 have been approved, having passed through our proprietary rigorous twin-lens approach which analyses for impact and investment.
Unsurprisingly, passive funds have been a large driver of growth of the ESG market in Europe and by the end of 2020 accounted for 22.5 per cent of funds by number4. While requiring even less fund manager oversight and a greater reliance on third-party data, which may have been subject to lower levels of scrutiny, passive funds generally have no expectation of engagement with management teams over non-financial issues.
This is not a new concern, but it serves as a reminder that ESG alone is unlikely to create a culture of engagement with management teams to effect positive change. We’re conscious of the relative ineffectiveness of ESG compliance compared to more action orientated funds, which are prioritising a higher standard of responsibility and sustainability in their engagement.
The recent example of the activism of Engine No.1 LLC in Exxon5 is a case in point. Exxon wasn’t being influenced by the criticism coming from the responsible investment community and omission from ESG indices. Instead, the active engagement of the Engine No.1 LLC hedge fund has potentially delivered significant change, with three “climate friendly” board members appointed and a demonstrable change of tack now more possible at one of the world’s largest carbon emitters.
The Roadmap should help resolve many of the issues we’ve mentioned here. Companies in the real economy will be required to provide more sustainability information to the financial services industry, in particular assets managers, who in turn will be required to make changes to how they provide information on both their own sustainability and that of their products, through improved product disclosure.
It has outlined a similar level of concentration on sustainability for the financial adviser community too, although this will come in a later phase. The Roadmap stated, ‘HM Treasury and the FCA are exploring how best to introduce sustainability-related requirements for financial advisors.
‘A key aim will be to ensure that they take sustainability matters into account in their investment advice and understand investors’ sustainability preferences to ensure suitability of advice. Details of the proposals are subject to further consideration and will be set out on a different timescale to proposals for financial market participants. The proposals will be subject to consultation and cost benefit analysis.’6
Greenwashing and the lack of rigorous due diligence amongst ESG asset managers has become a true business risk for financial advisers. Similarly, a lack of sustainability expertise amongst those picking funds could prove problematic. ESG may be a good start, but to thrive in a world after COP26, it’s likely not enough.
More information of Tribe’s Sustainable Impact Model Portfolio Service (SIMPS) can be found here. The SIMPS now available risk profiled on Dynamic Planner are:
Important Information: Tribe Impact Capital LLP is authorised and regulated by the Financial Conduct Authority (“FCA”). Our FCA registration details are set out in the FCA Register under Firm Reference number 756411 (www.fca.org.uk). Tribe Impact Capital LLP is registered in England and Wales (registered number OC411984) and our registered office is 52 Jermyn Street, London SW1Y 6LX. This document does not provide you with enough information to make an informed investment decision. Neither does it constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individual clients. If you are not an existing client of Tribe Impact Capital LLP, this document is considered to be marketing material. Whilst this document may contain information about specific companies it is not an investment research report as defined by the FCA. This document is not intended and should not be construed as an offer, solicitation or recommendation to buy or sell any investments. You are recommended to seek advice concerning suitability of any intended investment decision from your investment adviser. Past performance is not a reliable indicator of future performance; and the value of investments, as well as the income from them can go down as well as up. Investors may get back less than the original amount invested. Any type of impact investment will involve risk to investors capital and the expected environmental or social return may not be achieved. The information and opinions expressed herein are based on current public information we believe to be reliable; but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information herein is given in good faith but is subject to change without notice. No liability is accepted whatsoever by Tribe Impact Capital LLP or its employees and associated companies for any direct or consequential loss arising from this document. This document is not for distribution outside the European Economic Area.