The current proposals will mean that advisers will have to determine and document their client’s ESG preferences and recommend investment products and services that are suitable.
It is worth noting that the FCA has indicated that it will be implementing these rules and making the required changes irrespective of Brexit.
For discretionary investment managers, this will mean that, when providing information to a client regarding the types of financial instrument that may be included in the client portfolio, the portfolio manager would have to take into account the client’s ESG preferences.
Regulation is likely to bring change in this area, but another reason that we are seeing bringing ESG more into the mainstream is demand from the actual clients themselves.
A lot of this client demand is coming from the younger clients and millennials who will benefit from the transfer of wealth we spoke about earlier.
ESG investing is not without its challenges though; research can be complex with a lack of standardisation in definitions in this market and third-party assessment of ESG funds differing, sometimes wildly.
We also now have a new word to add to our vocabulary: ‘greenwashing’, which is the practice of making funds appear to be more ESG by providing misleading claims in order to capture ESG investment.
So, what can we say about ESG and what is the easiest way to construct a portfolio based on it? We had conversations with a number of people connected with ESG about what they thought was particularly important when looking to invest in this area.
There was a wide range of opinions but one of the simplest and we think the best offered to us is to invest by concentrating on the “G” in ESG.
The theory behind this is that everything in a company stems from governance. If the governance is not right, then the business is fighting against internal tides.
A company with good governance should be alive to regulatory issues, environmental issues and the pressures to invest on a responsible basis more than any other and, in addition, it should be in a better position to achieve these goals than a company without good governance.
So that’s one potential starting point. What else is there to consider?
“ESG” is comprised of three separate and distinct elements: Environmental, Social and Governance.
The problem is that, because the elements are distinct, they could score highly on one but not on the other two.
This has led to issues in the past, for example where companies have been judged environmentally sound but have ultimately failed due to poor corporate governance.
So, it is best to try to analyse the three elements and decide which is the major factor with regard to your clients. Once this has been identified, the DIM can then give the requisite caveats about investing in this area.
