Worthstone’s Gavin Francis discusses why the lack of standardisation on definition and reporting means that advisers face a huge challenge when trying to accurately assess sustainable investment funds.
The way investors think about money is changing. Increasingly, people want their capital to make the world a better place. It’s a trend that’s surged since the COVID-19 pandemic, and with the UN climate change conference COP26 taking place this month, it’s in the spotlight now more than ever.
In our experience, the question from advisers over the last couple of years has changed from ‘should you look at these investments?’ to ‘how good are these investments?’.
ESG funds are widely seen as the de facto option when it comes to investing “ethically”. By some estimates, a third of all assets under management now take into account some ESG aspects in their investment strategy. And, according to Bloomberg, the value of the market is set to rise to $53 trillion by 2030; currently it’s worth around $37 trillion. By Worthstone’s last calculation in October 2021, the total assets under management available to UK retail investors (and daily traded) that incorporate sustainable mandates is £230 billion – up from £87 billion in June 2017. Focusing solely on ESG, however, can blinker an adviser’s view of the wider landscape, with a far more complete picture provided by impact investing.
ESG aims to do no harm, but is this enough?
ESG investing considers the ethical impact of funds, ostensibly eschewing harmful practices like arms, oil and alcohol. The aim is to avoid doing harm (well, most of the time anyway) but is simply doing no harm good enough anymore?
Climate change and increasingly extreme weather events have caused a surge in natural disasters over the past 50 years. We’ve lost millions of lives and spent untold figures on trying to rebuild cities and societies. The panic is palpable: people are anxious and want to take action.
Investing in impact allows people to do just that: it goes beyond doing no harm, and actively supports activities that aim to make a positive change in the world, both on a social and environmental level.
Impact investing incorporates financial and non- financial returns
The bottom line in ESG is purely commercial, and a fund manager reserves the right to maintain financial return at their discretion. This means potentially ploughing capital into the very activities ESG is meant to avoid. ESG stands for environmental, social and governance, but perhaps employ scepticism generously would be more apt.
Impact investing also seeks financial return, but rather than the bottom line it’s a dual-purpose alongside a focus on specific outcomes – aka “doing good”. And return is viewed as a long-term project. By creating positive change, the aim is to combat damaging consequences that harm the world and hit individuals and communities financially, whether this is natural disasters, war or corruption.
There are non-financial returns too, like creating a fairer more inhabitable world. These are emotive elements that really resonate with consumers.
Tapping into your clients’ values is key here. What “returns” do they want to see? By investing in impact, clients have the opportunity to address some of the world’s most pressing challenges, whether that be through renewable energy, sustainable agriculture or sustainable infrastructure development. The scope is huge here; by asking the right questions advisers can get to the crux of what it is their clients care most about.
Lack of regulation means ESG can be a minefield for advisers
Advisers that we work with consistently tell us that clients who invest in this way want to know where their money is invested and what it’s doing. There’s an increased demand for thorough and detailed reporting, which, not only meets clients’ expectations, but inevitably holds fund managers accountable too.
Despite recent initiatives to regulate ESG, a defining feature of ESG investing is a lack of standardisation on definition or reporting. Scoring for sustainable funds is in its infancy, leading to a disparity of ratings. The term ESG is also open to interpretation, so firms are declaring themselves ESG-compliant without any accountability. It’s a minefield for advisers who often struggle to know what’s under the label of a fund, thus making it tricky to prove to clients that their money isn’t actually doing any harm, or whether or not it’s making a positive impact at all.
Impact investing on the other hand is defined by its standardisation. An agreed set of yardsticks means funds can be objectively compared and rated. Key metrics include a fund’s contribution to positive social and environmental outcomes and the extent of a fund’s exposure to stocks commonly associated with harmful environmental impacts. Reporting back to a client is much more straightforward and because positive outcomes are achieved in a strategic way, they can be replicated.
How is impact measured by Worthstone?
- Positive impact – we rate a fund’s contribution towards positive social and environmental outcomes by mapping underlying company revenues against the investable UN Sustainable Development Goals to articulate impact.
- Active Agent – we assess asset managers based on their actions across four components to measure their level of commitment to stewardship, active engagement and transparency.
- Avoidance of harm – scores are based on the extent of a fund’s exposure to stocks commonly associated with harmful environmental and social impacts.
- ESG – operational impact measuring the Environmental, Social and Governance (ESG) practices and opportunities associated with a fund’s underlying holdings, providing insight into resilience to long-term, financially-material ESG risks.
- Carbon risk – the material financial risk associated with a fund due to the implications of projected environmental policies and transitional and physical impacts of climate change.
Advisers have a responsibility to find out the purpose of a client’s investment
A financial adviser has a responsibility to find out the purpose of a client’s investment and help them articulate this. And with more and more consumers wanting their money to do good, ethical investing isn’t just increasing in prevalence but importance too.
So, much like you’d ask a client if they want to increase their income, advisers should also be asking clients if they want to make a positive impact with their investment. And for those clients who really want to make a change, not just avoid doing harm (most of the time), impact investing should be in an adviser’s arsenal of advice.
We’re not saying this is an easy task, nor is it useful to shame clients into “doing good” with their money: it’s their agenda at the end of the day, not ours. We do, however, need to find a way to unlock latent demand – if it does exist. This, in itself, is incumbent on the adviser as a professional to meet their clients’ objectives, however challenging it may be to uncover these.
Top rated impact funds this quarter
Each quarter Worthstone reviews and compares 400 retail investment funds which have a sustainable mandate against five key metrics and using 250 data points.
- FP WHEB Sustainability
- Impax Environmental Markets
- Triodos Pioneer Impact Fund
- Federated Hermes Impact Opps Equity
- Mirova Europe Environmental Equity
- Impax Asian Environmental Markets
- Mirova Global Sustainable Equity
- BNPP Aqua Privilege
- BNPP Climate Impact
- Alquity Future World Fund
Find out more about impact investing
Through its online database, Worthstone’s comprehensive rating system examines all aspects of impact investment, giving advisers the full picture so they can make sure their clients’ money is doing exactly what they’d intended.
Worthstone’s annual Impact Investment Academy (IIA) brings together world-class influencers and industry leaders, providing thought provoking talks, insight and best practice. This year, the IIA will be looking at the difference about ESG and impact investing.
To find out more about the virtual event, which this year takes place on 16 November, and book a spot, please go to www.worthstone.co.uk/impact-investment-academy/ next-event/
Gavin Francis is the CEO and founder of impact investing specialist Worthstone.
Gavin founded and launched Worthstone with the express purpose of helping bring the social impact investment market to maturity amongst financial planners and wealth managers.