On December 4th, 2018, in an article for Citywire Wealth Manager, Paul Warner (Senior Investment Manager) warned ‘as the environmental, social and governance universe continues, investors should beware the band wagon jumpers’. Since this caution, in July 2019 it was made public that a $500 million ETF run by a prominent asset management company, that had claimed to specifically exclude fossil fuel stocks, was investing in a host of companies in the oil and gas sector.
This once again substantiated concerns that investors are being misled by products claiming to be socially and environmentally focused. The growth of ‘green washing’ (the attempt to capitalise on the growing demand for products that are environmentally sound, by giving a false impression of a company or product to make it appear more environmentally sound than it actually is) is becoming a larger issue and undermines public confidence in SRI / Ethical investing and its effectiveness to achieve good.
The terms ‘ESG’, ‘SRI’ and ‘Impact’ are often used interchangeably in the financial industry, which then generates assumptions that they all match in both meaning and approach, despite there being distinct differences between them. Due to this, investors may assume that an investment / product with ‘ESG’ in its title complies with their values and ethical objectives, and that their money is ‘doing good’ as they intended.
ESG refers to the environmental, social and governance practices of an investment that may have an impact on the performance of that investment. It is an additional tool to technical valuations and while there may be some limited overlay of ‘social conscious’ the main driver of ESG evaluation is still financial performance. Investments with good ESG scores have potential to drive returns. Likewise a good ESG score will indicate decreased risk exposure to negative consequences of industrial or commercial activity that has caused adverse external effects (e.g. pollution), and the financial liabilities that occur as a result.
Where ESG assessment is a score, an indicator of the risk to an investor posed by the business activities of a company and its potential to have an adverse external impact, SRI and ethical investing is far more significant and value driven. SRI / Ethical investing is concerned with the impact on society and the environment, not just the impact on the return of an investment. SRI and ethical investing, begins with a screening process. Ethical investing starts from a position of ‘do no harm’ and requires strict negative criteria and areas of avoidance e.g., tobacco, weapons, animal testing. SRI starts from the premise of ‘do good’ and involves positive screening where an investment has to demonstrate a positive impact on the environment or society.
With the increased awareness of sustainable investing and investors seeking an investment that can align with their values there has been a huge increase of ETFs with ‘ESG’ or ‘SRI’ in their name. Many passive ETFs and open-ended funds can exploit a need for low-cost solutions, rather than genuinely providing the sustainability outcomes that investors are seeking.
When looking at these passive ETFs, in the majority of cases their SRI strategy is purely to track an index minus any exclusions (such as weapons / tobacco). In passive ETFs, a share is either in the index or it is not. Where the world and its difficulties are complex, an index is defined simply by what is included. With active sustainable investing, there can be holistic and integral attention to all environmental, social and governance issues. This requires research rather than algorithms, more so when the available data is not standardised or consistent.
Although passive sustainable investing offers a cheaper solution, this can come at the cost of a lack of scrutinised selection, additionally this prevents an active corporate engagement approach. Passive sustainable investment can certainly look like an attractive green option in the market, but genuine sustainable investing requires deeper research and positive screening rather than purely excluding areas of avoidance.
We have been running SRI and Ethical mandates since 1994, long before it became the ‘fashion’. Before we even start to analyse the fundamentals and performance of a fund for inclusion in our models, we have to first establish it meets our screening criteria and is therefore allowable in our models. This is a stringent process, and we do not compromise on our avoidance criteria or our positive criteria. A fund must have documentation that clearly outlines its investment policy and its screening processes. If there is not enough information to confirm it is compatible with our requirements and the needs of our clients, we will approach the Fund Manager for further clarity, and if after this there are still any gaps in meeting our stipulations, then the fund will not be permitted. We also scrutinise the top ten holdings of a fund to ensure that there is direct correlation between what is stated in their policies and what is present in investment practice. Once a fund has made it into our models, it is subject to regular reviews, including fund manager interviews and ensuring we are familiar with fund updates / the latest published documentation.
In a world of increasing ESG tokenism and ‘green washing’, we are committed to our principles and have an over 10-year record of providing a genuine SRI / Ethical investment solution focusing on the objectives of our clients, and the good of the environment and society. Values and principles are not quantitative, there is no mathematical formulae that can assess them. This is where we would hope to add value, acting as the gatekeepers for IFAs and their clients, to ensure only investments that reflect their principles make it through the gate.
We have taken our experience and process and utilised it to produce a sustainable range of models in addition to our SRI and Ethical range. We have used our SRI screening methodology and philosophy in combination with Alpha Beta’s Dynamic Asset Allocation and Risk First investment process. This range offers an accessible opportunity for investors who wish to start profiting while making a difference to the world around them. Where we have used passive investments for cost and asset allocation purposes, these have still been through the screening and research procedures that the funds within our SRI and Ethical models go through. This range provides an opportunity for the conventional investor to ease into the responsible space and profit from doing good through a light green, risk managed approach