In the last few years, many investors have faced moral dilemmas about their investments. Directly or indirectly contributing to a company's growth that may be responsible for the destruction of natural resources or promoting unethical work practices, has led to a shift to sustainable investing. Also known as Environmental Social and Governance investing (ESG), sustainable investing is seen as a way to ethically grow your wealth.
According to Morningstar, between April and June, as the COVID-19 pandemic gained speed worldwide, funds that prioritised ESG investing saw global assets under management hit a record $1 trillion.
But sustainable investing is still a relatively new genre of investing, and there is still a lot of ambiguity surrounding the topic. According to a background paper on Responsible Investment in New Zealand by KPMG, fund managers, investors and regulatory bodies find it challenging to keep pace. It has reviewed publicly available information for funds from KiwiSaver providers as of April 2019. The most significant shortcomings and risks to responsible investment by KiwiSaver funds and providers include ambiguous and inconsistent terminology; vague policies; confusing documentation; redundancy; and immature processes. Only this week the Financial Market Authority announced it would be policing the responsible labelling or 'greenwashing' of investment funds that may not be true to type.
However, if you wish to embark on this road, firstly kudos to you and secondly here are three important questions that are important to ask your financial adviser.
1. Does sustainable investing mean I have to compromise returns?
One thing holding advisers back from embracing sustainable investing is confusion around financial performance. According to research and analysis conducted by Cerulli Associates, more than a third (35%) of advisers who do not currently employ ESG strategies cite concerns about its potential impact on performance as a deterrent, with 75% noting that it is at least a moderately important factor in their decision-making process.
It is believed that companies that prioritise responsible and equitable business practices — including environmental safety, workplace diversity and strong corporate governance will, in the long run, outperform those that do not. Data from financial institutions such as JPMorgan, BlackRock and Goldman Sachs suggests that the consideration of ESG factors can provide investment advisers with full context on the risks of investing in a company without compromising returns and, in some cases, even exceed the expected returns.
There is a growing body of research that uses backtesting simulation to illustrate the impact of ESG integration on various investment strategies.
2. How can I align my investment portfolio with my values?
Advisers should be prepared to engage in conversations that places the client's needs at the forefront. Developing a robust understanding of clients' values can be a complex process that involves multiple considerations and trade-offs, often not so simply distilled to "reducing carbon emissions" or "investing in clean energy."
For example, many clients will approach an investment adviser with the goal of divesting from oil and gas while simultaneously investing in companies that are the largest supporters of clean energy. However, the inconvenient reality around clean energy is that some of the largest oil companies have invested heavily in renewables, such as BP's ambitious plans to transform itself from oil to clean energy producer.
That's why, before embarking on a sustainability journey with a client, it's important first to engage them in a candid conversation to clarify their expectations and explain the trade-offs inherent to investing for environmental and societal impact, while concurrently discussing traditional metrics such as returns, index-tracking error and risk tolerance.
3. Can you show me how it is decided if a company is socially responsible?
In 2019, the asset management giant Vanguard ejected 30 stocks from its ESG funds created to invest in companies with strong environmental, social and governance records. Among these companies, a private prison operator (Geo Group), a restaurant operator (Yum Brands) that owns KFC, a pharmaceutical company (GlaxoSmithKline), a gun manufacturer (Sturm Ruger).
This incident is just highlighting a typical issue with ESG-branded index products. In many cases, the fund manager's methodology for creating an ESG index is not transparent and leaves investors confused.
Although independent ESG rating companies worldwide have sprung up to fill the gap, they don't always see eye-to-eye. For example, Amazon.com Inc. has been accused of dangerous warehouse practices but has pledged to become net carbon neutral by 2040. Market darling Telsa is ranked at only 431 of the 500 companies scored in order of their green credentials by Newsweek, a progressive publication.
To sum it up
As a financial adviser, I think there are different flavours and no one-size-fits-all approach to ESG investing. When considering different asset classes, different methods are better suited than others for different types of investors.
Some asset managers want to maintain a "seat at the table", so their investors can consider the investment impact to drive positive change.
For instance, several venture capitalists observed that in the food and beverage industry, the idea of "doing good" as a company is quickly evolving from "nice to have" to "must-have" to raise capital. In other words, just saying "99% sugar-free" on the label won't cut it anymore.
Global fund manager Dimensional says, by using a holistic scoring system rather than a completely binary "in" or "out" screening process, investors may be able to preserve diversification while recognising those companies with positive environmental profiles.
To conclude, it's important to have a financial adviser by your side who can design an approach to preserve diversification across the portfolio and within sectors while accounting for the reality that some sectors tend to be more significant contributors to ESG concerns.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from a Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
