Investors’ increased interest in understanding how their money impacts the world or how risks arising from environmental, social or governance (ESG) related issues, is at an all-time high. For advisers however, this also creates potential challenges as the non-homogeneous nature of ESG and the differences in beliefs, values and priorities of investors make addressing these issues a highly subjective and complex process.

Understand the landscape

It’s generally accepted that all Responsible Investment (RI) strategies can be broken down as follows:

• Exclusions (negative and/or norms-based screening)
• Best-in-class
• ESG integration
• Thematic
• Impact
• Active ownership

Strategies with a defined focus on RI utilise one or more of these to achieve their objectives, with each having a different outcome on returns, risks, costs and outcomes. Importantly, each strategy may have greater or lesser utility regarding investor objectives.

For example, exclusion-based strategies may be more suitable for investors focused on avoiding certain sectors based on their values or beliefs. Impact strategies, however, are more suited to those with a specific focus on generating a positive environmental and/or social impact around defined goals.

Once a strategy is identified, a more targeted assessment can be made on its utility, the manager’s implementation, and its overall effectiveness in achieving its defined goals. We believe that breaking down these nuances allows the adviser and client to make a more informed choice, and thereby facilitate the most optimal fit.

Create an investor framework

Generally, investors sensitive to RI exhibit one or more of these three basic characteristics:

• Values: ‘My investments should reflect my values’ (i.e. screening for controversial activities which may be ‘E’, ‘S’ or ‘G’ related)
• Impact: ‘I want my investments to make an impact on the world’ (i.e. generating positive social or environmental impacts alongside financial returns)
• Integration: ‘I believe incorporating ESG improves results’ (i.e. ESG factors can be used to identify outperforming companies or avoid companies likely to face ESG headwinds)

Once viewed through this lens, an adviser can start to narrow down which RI strategies may have greater utility for the client’s goals.

Starting the conversation

Naturally, asking outright questions about responsible, sustainable, or ethical investing may not deliver the best results, as many clients may not clearly understand either what’s meant by these terms, or the nuances between them.

Open-ended queries may allow a more indirect approach, such as "are there any companies or particular industries you would like to avoid in your portfolio?" Alternatively, you could ask “are there any issues that you feel strongly about that we should consider when selecting investments for your portfolio?”.

Include questions to find out if there are any issues, companies or sectors that the client would like to support in their portfolio. When questioning clients about their RI preferences, you also need to consider any trade-offs to ensure answers aren’t being skewed by emotion. This highlights the challenges of building a well-diversified RI portfolio which isn’t overexposed to certain style biases.

Importantly, investors should start thinking about ESG as a theme, not an asset class. It should be recognised that many fund managers already utilise some form of ESG overlay and pursue active stewardship. This effectively means that regardless of whether you choose a fund that’s pursuing a specific ‘deep green’ agenda or not, when investing with large fund managers, you’re likely to still have some form of ESG overlay.

Recognise that everyone’s values are different

While we broadly consider the increase in RI strategies as a positive, we’ve observed that defining how investment managers integrate RI issues into their methodologies is an industry challenge. We believe advisers need clear, consistent disclosures that make it easy to understand what investment managers are actually doing when considering RI issues.

To better support advisers when assessing an investment product’s approach to RI, last year we launched our RI Classifications which will be available on the majority of rated products in our investment universe by 30 June 2021 (insurance-based products are excluded).  

Ultimately, the classification system seeks to identify the level of RI integration in the investment management process with reference to not only how managers assess and incorporate RI issues, but also their interaction and engagement with issuers of securities.

Expanding RI capabilities 

Pleasingly, as our RI capabilities continue to expand, we have a number of projects in the pipeline to bring additional RI tools to our clients, which we hope to share further information on soon. We’re also excited by the growing engagement that we’re having with advice practices on developing customised RI portfolios, which now total almost $100m.

If you’d like to discuss how we can assist in building a diversified portfolio of investments tailored to your clients’ values and beliefs without compromising on returns, please contact our Sales or Consulting Team to discuss further.