At a recent webinar on the subject of ESG, two fund managers from global firms claimed that ESG criteria underpin every purchase across all funds. This did not come as a surprise to us, as we had heard similar claims during our fund manager interviews. What had surprised us was that the claim didn’t appear to have reached the distribution teams and certainly not financial advisers. Furthermore, it is doubtful that research and data providers would class the mainstream funds of these managers as ESG compliant – they need to wear a badge to get there.
This presents a problem for advisers who wish to employ mainstream funds in a CIP that will meet future regulatory requirements on sustainability and which we believe should be the default solution for most advisers for most of their clients. Our research tells us that most consumers don’t want to do harm; they like the idea of sustainability, but don’t want to invest according to any specific passion and, crucially, they don’t want to miss out on returns. Interestingly, most advisers are in a similar place.
However, if the core, mainstream funds are not ESG badged, why should the adviser believe they fit the bill? Are they going to believe the grand claims on the website? We suspect not.
The fundamental issue that needs to be addressed is transparency of investment research, specifically, how is a stock researched before it is selected for inclusion in a fund?
There are some 41,000 listed companies in the world; 2,800 companies are listed on the NYSE; the FTSE all share index includes 600 companies – in short there is plenty of choice for the stock picker. Yet the choice is the problem. How do analysts acquire good data on so many companies in order to get to a viable population from which to make their selections? Data providers such as MSCI (7,500), Sustainalytics (12,000) and Refinitiv (9,400) provide ESG ratings and data on thousands of companies – individually shown in brackets. The problem here is that non-financial disclosure is, for the time being, voluntary self-disclosure. Ideally, the fund manager or analyst will screen using the quantitative data and then assess the company robustly by visiting or interviewing and asking the difficult questions.
Advisers will need to be confident that their chosen fund manager has a process that cuts out a potential Boohoo from the selection process. Otherwise, there is no credibility.
In the shorter run, we have to work with what we have. Investors cannot wait until there is global regulation of company data disclosure. We believe that the key to credibility is transparency of process and numbers. We need to know what data providers they use, why and how. We need to know how many are initially screened and then how many are forensically examined. Too many means too little examination; too few means the population is too small for investment selection – a tough dilemma.
In the medium term, organisations such as the Task Force on Climate Related Disclosures (TCFD), the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) are working with regulators such as ESMA. ESMA’s proposed Sustainable Finance Disclosure Regulation will ensure there is a standard of trustworthy non-financial disclosure in the EU and it is hoped other regulators will follow. HMG has said UK regulation will be equivalent or tougher. Now there is more hope as the four big accounting firms have unveiled a framework for ESG standards.
Maybe it is not crazy to foresee a day when data is sound and consistent, and measuring companies performance on a range of ESG criteria will just be part of what fund managers always do and so the term will become redundant. We can dream.
About the author
Clive Waller is Director at NextWealth and co-author of the recently published ESG Tracking Study: It’s about risk report. Clive is also chairman of The Investment Network and the Schroder UK Platform Awards.
To download the our recent ESG Tracking Study: It’s about risk, click here.