(Money Marketing) - Whether it is consuming less water in the shower, using a reusable coffee cup or even eating less meat, living a more sustainable lifestyle is becoming more commonplace and achievable as each year passes.
A sustainable life can also come down to how you invest. As environmental, social and governance (ESG) funds have come into popularity over the years, more and more investors are going to their advisers asking for it to be included in their portfolios.
While there have been many fund managers who have had the capabilities and focus for this way of investing, for many it is still relatively new. And with a new ESG fund being launched seemingly every month, proper due diligence is more important than ever.
I love educating clients on all the opportunities that are out there in the ESG space
ESG funds can typically have better returns than non-screened funds, but it can also mean that with a smaller number of investments within a fund, it could end up being more volatile. As such, due diligence is of increasing importance to advisers looking to recommend these types of funds to their clients.
Covering the bases
Due diligence is undertaken in every step of advice, but having a relatively new (to some) area of investment, advisers need to be making sure they are doing the right things for their clients.
For TAM Asset Management chief investment officer James Penny, there are two ways to undertake due diligence on ESG funds. First is to have a proper conversation with investors about their views, beliefs and what they want from their investments.
He adds: “Have you got a robust process for establishing exactly what your client wants or have you just heard the ESG buzzword and fired off to buy Baillie Gifford Positive Change fund and think you’ve done it?
Getting in with the fund managers, seeing the whites of their eyes and understanding their approach to ESG are really important
“There are so many questionnaires or ways of using conversations with clients to not only inform them but make sure they are getting what they want.”
Foster Denovo head of investment research Declan McAndrew agrees.
“As advisers, understanding our clients’ needs and specific goals is, of course, of the utmost importance. Asking relevant open questions and, above all, active listening are essential components of the client relationship.”
He believes this has never been truer than when discussing ESG and sustainable investing.
“By taking the time to listen to clients and understand what their ESG investment goals, beliefs and ethos are, we can advise them appropriately in a way that both considers their sustainable criteria, while also delivering returns and helping them meet their long-term financial goals.”
Managing client expectations is key for any type of investment, but particularly with ESG, as many will still have the belief that ESG means limiting investment choices and thus returns.
Investing in ESG does not bring limitations. For example, Penny says that when looking at the fixed income space recently he came across 47 classifications for green bonds. This can bring complications.
Asking relevant open questions and, above all, active listening are essential components of the client relationship
“You need to establish due diligence for your clients as it is not just simple ESG, but many varieties. And how else would your client know about it without being informed about all the options available to them?”
Penny continues: “It may be that there are some clients who say they simply don’t want companies that use animal testing or fossil fuels. That’s admirable but if they understood a bit better about what’s in the market, they could get really excited about the whole investment opportunity.
“I love educating clients on all the opportunities that are out there in the ESG space. They find out that there is so much more on offer than just having a portfolio that avoids animal testing or fossil fuels. They could be missing out on ground-breaking stuff that others are doing.”
McAndrew adds that his firm has ESG-specific questions to gain further understanding of whether clients have any prior understanding, and if they are looking to make an impact with their investments or just want to filter out ‘bad’ companies.
Defining moment
He also believes the first step with clients is to let them know exactly what the firm means when it says ESG and sustainable investing, as there is no universal industry-wide definition.
“Articulating the scope of the options available through a pictorial spectrum of capital can be useful when explaining the transition from traditional financial-only investing, through to responsible, sustainable and impact investing.
If clients understood a bit better about what’s in the market, they could get really excited about the whole investment opportunity
“Supplementing this with client-facing material to explain how the current ESG investment fits into the history of ethical investing have proven invaluable in providing context and avoiding misapprehensions.”
He adds that rather than treating it as a separate entity from the first factfind or ‘Getting to know you’ meeting, it should be incorporated into the other sustainability assessment portions, “including the level of risk the client is able and willing to take, the impact that any financial loss could have on their finances, as well as their initial level of investment knowledge and experience”.
Point of access
Access to information with ESG investments is vital. TAM’s Penny says one needs a point of access with fund managers, which is where outsourcing can help.
“If you want to properly do your due diligence, but all you have is Google, some performance reporting and a fact sheet, you can only do so much. But getting in with the fund managers, seeing the whites of their eyes, and understanding their approach to ESG and what they wouldn’t touch with a barge pole, are really important.”
He adds that it is, understandably, difficult for smaller advisers with 20-30 clients to walk into somewhere like a Goldman Sachs and ask to speak with a £3bn ESG portfolio manager.
“They just don’t have the time,” he says.
Articulating the scope of the options available through a pictorial spectrum of capital can be useful
Outsourcing can help with gaining access by partnering up with someone to do the due diligence.
“You have got to do hours and weeks of work to find out the right investment product for the client,” says Penny.
It is always worth keeping an open dialogue with clients and continuing research as part of an ongoing process, regardless of the type of investment.
ESG is an area that is constantly progressing, with new vehicles available for investment being launched regularly. Due diligence is always an area that advisers need to keep at the forefront of their minds, but when it is a fast-paced type of investment, seeking solid research functions for your clients is also a necessity.
