Few areas of investment management have seized popular attention as rapidly and universally as those that embrace a responsible approach to investment. According to FE Analytics, from an average of three fund launches per year in the 1990s, the last three years alone have seen on average 32 new responsible funds come to market each year. 
This prolific increase in responsible funds mirrors a shift in the broader popular opinion, as evidenced by movements to halt climate change, calls for greater diversity and social inclusion and celebrities flaunting recycled fashion at A-list events.
Never has the consumer been more aware of the impact that their personal life choices can have on the environment and society as a whole, resulting in a growing investor demand to align their investments with their moral compass.
With this heightened focus on investing for the greater good, comes a shift in the way responsible investment is viewed and so some context might be necessary. Traditionally, the majority of funds sought to meet investors’ ethical requirements by excluding ‘sin’ stocks such as armaments, tobacco or fossil fuels.
However, the market has since evolved to include funds which are managed using a responsible investment approach, aimed at being a positive force for change. These funds can, and do, still use exclusions but can also be focused on sustainability and impact.
At the same time, the concept of ESG integration is moving to centre stage.
This describes an approach to risk reduction – it is an input into the investment process, an additional lens as part of the due diligence. It is aimed at mitigating the impact of non-adherence to environmental, social and governance issues on profitability. Whilst ESG is not in itself a measure of responsibility, it facilitates a process of measurement which advisers and consumers can use to differentiate between funds based on the approach taken to these issues by the companies in which a fund invests.
However, ESG integration no longer ends with the businesses to which asset managers have exposure, in fact, investors are becoming increasingly eager to see that the fund groups themselves apply these same standards to their own operations.
This interchangeability of terminology around responsible investment and ESG has led to some confusion which has the potential for exploitation. The proliferation of responsible funds and the dominant discussions around ESG integration might lead the cynic to suggest that fund groups have identified an attractive bandwagon on which they are now vying to secure their place. As ESG and responsible investment have become engrained in investment conversation, so has talk of green washing.
This describes the practice of over-emphasising ‘green’ credentials and is directed both at responsible funds and to the companies in which they invest. Without doubt, there are a number of funds available that have fully embraced ESG in their investment process, as well as some asset management groups who are serious about integrating these considerations across their businesses.
However, this is not universally true, creating a challenge for advisers and consumers seeking to differentiate those companies and funds that have fully integrated ESG or adopted a responsible approach to investing and those who are exploiting a convenient marketing badge.
So how can fund selectors and investors assess whether fund groups are dedicated to the concept of ESG or simply paying lip service to it? How can you gauge which groups are furthest ahead with their ESG integration?
A good starting point is to look at who is doing the work. Look at the asset management company itself, and the wider team behind a fund. Ask if they are living and breathing this approach or whether it is little more than a veneer. Has the company behind a fund invested properly in the approach and given their managers the appropriate tools to do their jobs? Do they use their own proprietary assessment metrics? If so, how are these calculated? Look at the data providers which managers are using, and perhaps more importantly ask how they are using them.
One issue with data providers is that they all look at slightly different considerations, which can end up giving a very different end result. Data can play a useful role, but it should be viewed with caution and managers should not blindly rely on it – they should prefer to assess companies themselves, at least to some extent.
In the future, it is likely that legislation will be introduced aimed at improving reporting and transparency on sustainability issues at a company level. This may well place the burden on asset owners to obtain data at source rather than on the companies to provide it. Nonetheless, the level of pressure which the fund manager can exert on companies should lead to a change in the level of willingness to provide detailed information regarding ESG practices.
In the meantime, data should be used with caution and a good dose of common sense.
Advisers and fund selectors also need to hold fund managers to account for the individual holdings in their portfolios. If they are not what is expected then, at the very least, a manager needs to have a solid explanation for their inclusion. If this is not forthcoming, a fund’s credentials are seriously undermined. This answerability on the part of the portfolio manager is crucial and they should own the dialogue on their portfolio holdings to be truly credible. If they are always buoyed up by an expert from the responsible investment team, it is unlikely that ESG is fully embedded into their investment philosophy.
Trust between the asset management industry and the public can at times be strained and it might take time for advisers and end investors to truly believe that fund managers place a higher value on ESG than on the profits of the companies in which they invest.
This is something that they need to demonstrate clearly. It is no longer good enough for them to claim that they integrate ESG across their business, or that they invest in a responsible manner. While advisers and investors need to be discerning in their fund selection, the onus is really on the asset managers to provide proof of their credentials though transparent reporting, not just to qualified investors and intermediaries, but to the end investors as well. More and more people want to see evidence of the influence and impact their investments have on the world: if asset managers cannot provide this, they should not be trusted with investors’ money.
Steve Kenny is commercial director at Square Mile Investment Consulting & Research. The views expressed above are his own and should not be taken as investment advice.