Following a two-year hiatus due to the pandemic, FundsForum – a major conference bringing together some 1,400 international investors – was back in person, providing the industry with the chance to discuss the latest trends affecting the economy and how the investment world operates. I joined the event, having been invited to chair an ESG panel discussion and participate in a separate session on asset allocation.
The session, How to avoid environmental, social and governance (ESG) greenwashing when creating or assessing ESG products, involved an investor, an ESG integrator (someone who seeks to integrate ESG factors into investment portfolios while mitigating the risks) and a legal consultant specialising in investment structures.
The debate sought to set out a path that the industry could start to follow given investors continue to increasingly demand more sustainable investment options. And while there has already been an explosion in the number of vehicles available in which to invest, across all levels of investor sophistication, we can expect more still. Regulators and governments too are also looking to investment houses to help them change the approach of companies through shareholder activism, while fuelling further growth.
But without a common framework, we risk seeing even more investment funds churned out that purport to be ‘doing good’, but are really just ‘greenwashing’. Here, unfortunately, they essentially spend more time (and money) promoting their investments as being sustainable and having a positive impact on nature or society, rather than actually taking the necessary steps to use their financial power to minimise the negative environmental and social effects companies are causing. Then there are those ‘green wishing’ that their products become more sustainable, at some point in the future, but without a clear plan or timeline in mind to achieve their aims.
The industry is also not helping its clients due to the mismatched language used, which only serves to confuse, regardless of whether the client manages a large pension fund or their own personal retirement portfolio. While the investment industry is conscious of the amount of jargon used when talking about anything to do with financial markets, the ESG world is particularly heavily laden with acronyms – as the use of three letters for the overarching approach shows!
As a result, investors struggle to find out if their investments are credible and will achieve the objectives set out in the all-important legal documentation. And the divergence in terminology creates challenges and pitfalls for the industry as well. It is all too easy to get caught up in a cycle of hollow promises for portfolio objectives instead of focusing on our duty of care for clients.
A tangential discussion focused on the importance of data, its use by investors to understand the impact of their investments and also how it is picked up and used by rating houses. Ratings have long provided a great way for investors to understand the difference between investment strategies, whether the rating focuses on the level of risk an investor would be exposed to, or is one that seeks to evaluate the experience and skills of the team of analysts and decision makers who manage the portfolios.
The issue here is that there are often discrepancies between the data providers, not least as there is no uniformity in how data is gathered, let alone how it is projected into future outcomes. As a result, it is very easy for anyone to be side-tracked by data that has been presented in a way that leaves it open to different interpretations when viewed through the various lenses multiple investors hold up. Unfortunately, this means that ratings poorly capture what they are supposed to set out, from the impact of the ESG efforts being funded through to their alignment with the UN’s sustainable development goals, which should allow people to understand what issue each of your underlying holdings is seeking to address and identify the related investment opportunities to deliver a return. But there is still time, given we are still really in the formation phase of the ESG sector, to find a way to clearly communicate investment objectives, how they are being measured and ultimately reached.
The debate also focused on the thorny issue of costs. Largely speaking, the costs of sustainable investment products are generally higher than those that are ‘just’ governance led. And this is justifiable given the increased need for data and other reporting requirements. The supporting sector is also still in its infancy. This means higher legal, reporting and labour costs.
However, there is a broad expectation that these higher costs should level off as we move into scale, not just as the industry becomes more aligned, but also given asset managers will increasingly realise that costs form an important part of the narrative with regard to performance. Given costs charged to investors can erode returns, if there is a long-running story of ‘lumpy’, fluctuating performance, the industry could shoot itself in the foot, not least as costs are often seen as fees.
One conclusion the investment industry has come to is that investors do not need to seek out those investment houses that set up ESG-focused investment desks decades ago. The industry has changed substantially since the term ESG was coined by Paul Clement-Hunt in 2004. Instead of a legacy, however, firms do need to demonstrate authenticity. This comes from having a considered and well-defined approach with a strong narrative as to why you invest in different ways for each of the different pools of assets.
What’s important for Nedbank Private Wealth clients to be aware of is that the industry is very conscious of the need to promote simplicity, a common language, aligned approaches to tackling issues, and objectives that are not grandiose statements such as, for example, the aim to ‘solve world hunger’.
And we are part of that debate, helping shape the future developments that will mean there is easy access to really sustainable investments that achieve what they say on the tin, but that also ensure the investment industry itself has a future that can be sustained.
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