ESG investing is about managing risk and will be integrated into core investment propositions by most financial advisers. This is the conclusion of an extensive research study that we published today on the ways that financial advisers will integrate ESG principles.

The report, ESG Tracking Study – It’s About Risk is available to download free from our website.

Our research shows that 78% of financial advisers include a question about ESG, ethical, impact or sustainable investing in the KYC process. But when we probed further, this typically falls under the ‘ethical’ heading. Rather than the far broader ESG heading. On average, 12% of advised client assets are invested in ESG, ethical, impact or sustainable funds or portfolios, up from 7% last year.

A near doubling of assets in a year is impressive. We think adoption will continue to accelerate and that this will be driven by ESG integration into the adviser’s core investment proposition.

The focus on ethical investing is not just embedded into the KYC but also the client’s mindset. We conducted two consumer focus groups for the research. (You can view highlights here). Our consumers kept coming back to ethical investing and low carbon investing – even after ESG investing was explained.

We created the following ESG Adoption Curve to illustrate where we find ourselves today. We think we’re at the end of the ‘Early Adopters’ phase. So far, ESG investing has been driven by consumer interest. People with a particular passion or interest transposed this interest to their investment portfolio. The early adopters built on growth from issue-oriented adopters through changing demographics, strong performance and press attention.

The real growth will come as regulation requires ESG principles to be integrated across the supply chain. This doesn’t mean only suitability for advisers. Regulators are requiring listed companies to publish data against ESG criteria. Regulators are also encouraging asset managers to consider ESG criteria. This will encourage ESG adoption into securities and the investment process. More important for fund groups is client demand. Institutional investors include ESG risk as a core element in decision making. This is trickling down to wealth managers and DFMs too.

This means that ESG principles will be incorporated into funds and portfolios whether or not retail demand rises.

Regulators also have their sights set on integration of ESG principles into the adviser process. We think this will fall under the heading of suitability at the FCA. Importantly our conversations with the regulator suggest that even if the UK goes its own way, withdrawing from MiFID as part of Brexit, the requirements to take account of the ESG risks of a portfolio and the client’s interest in sustainability are expected to be carried forward.

Avoiding expensive rabbit holes

We think ESG integration needs to happen at the adviser proposition level first. Most clients will be happy with an ESG-integrated core investment proposition and won’t need expensive bespoke solutions. Articulating a view on ESG principles as part of the values of an advice business, will ensure alignment with client needs. In the needs assessment, the challenge for advisers is to integrate a conversation about financial and non-financial goals without falling down rabbit holes that will lead to unnecessarily expensive bespoke solutions.

Thank you to the sponsors of the research: Aberdeen Standard Investments, Allianz Global Investors, Aviva Investors, Baillie Gifford, BNY Mellon, Dynamic Planner, FE fundinfo, Fidelity International, Federated Hermes, J.P. Morgan Asset Management, Janus Henderson Investors, LGIM, M&G Investments, Parmenion, Pictet, Raymond James, Regnan (in partnership with JOHCM), Schroders, Vanguard.

Again, free download of the full report is available here.