With more sustainable investment products than ever before, how can investors ensure their ethical values are truly reflected in their portfolios?
Numerous pieces of research have shown growing interest among all age ranges in ethical and sustainable investments, as investors seek to reflect their values in their portfolios.
According to the annual Schroders Global Investor Study, 54 per cent of UK investors have increased their allocation to sustainable investment funds, compared with five years ago.
Of the 67 per cent of UK respondents who acknowledged that sustainable investing was more important to them now than it was five years ago, a significant proportion cited the potential for long-term returns as a greater factor than ethical considerations.
In other words, it has become more than a simple “box-ticking exercise”, as Schroders' Jessica Ground observes.
She tells FTAdviser: “Making sure you are focusing on the material issues and what the company is doing in practice is vital. To do ESG well in a way that helps investment returns, you have to be prepared to do fundamental analysis.”
The types of products available to investors has become increasingly sophisticated to meet this widening investor interest.
Andrew Howard, head of sustainable research at Schroders, explained: “The market is maturing through an exciting shift where the attention turns from ESG as a generic idea, to the specific details of how different organisations and products are approaching the topic.”
John David, head of Rathbone Greenbank Investments noted: “For those looking to use their money to make a positive difference to society, making ethical consumer choices or boycotting a company that contravenes their own personal beliefs may seem like the logical choice.
“But there are other ways of driving lasting change.”
He called for the sustainable and ethical investment community to do more to raise awareness of the choices available to investors.
Ellie Duncan is deputy content plus editor at FTAdviser
Clients increasingly seeking ethical investments
Advised clients are increasingly seeking ethical investments, particularly clients aged 25-34, research has suggested.
In a survey of 1,500 UK adults, carried out by Atomik Research and commissioned by Rathbone Greenbank Investments, 18 per cent of respondents wanted to put more ethical investments into their pension pots.
More than 23 per cent also said they would not like to invest in companies with whose business or conduct they disagreed.
John David, head of Rathbone Greenbank Investments, commented: "For those looking to use their money to make a positive difference to society, making ethical consumer choices or boycotting a company that contravenes their own personal beliefs may seem like the logical choice. But there are other ways of driving lasting change.
"What many consumers aren’t aware of is how ethical and sustainable investment can be a powerful tool in helping to shift the mindset and direction of a company."
He commented that initiatives such as Good Money Week could do "a great job" at increasing consumer awareness, but added that more needs to be done by the ethical and sustainable investment community to raise awareness of the choices available.
"Advisers, too, can play their part in promoting ethical choices among their clients," he added.
The research also showed a large generational divide in attitudes towards ethical investment, with those aged between 25-34 far more likely to get involved with social impact investing (at 36 per cent) than over 45s (at just 6 per cent).
Some 28 per cent of the 25-34 age group said that using shareholdings to impact a company’s activities positively was the best way to use money for good, again contrasting sharply with the 5 per cent of over 45s.
In a poll taken among financial advisers for FTAdviser Talking Point, 36 per cent of advisers said more than 10 per cent of their client base were already investing in ethical funds or in sustainable companies.
According to the poll, 13 per cent said less than 10 per cent of the client base was interested in ethical investments, while 27 per cent of advisers said their clients had no money at all in ethical investments.
This comes as YouGov research for Good Money Week revealed that 47 per cent of UK adults said they wished their money to be invested with an element of making a positive difference.
Some 40 per cent wanted a fossil fuel-free option, up from 35 per cent last year and 32 per cent in 2015.
Moreover, 57 per cent of investors under 24 want to see fossil fuel free-fund options from financial advisers, but only 34 per cent of over 45s do.
As part of Good Money Week, the UK Sustainable Investment and Finance Association (UKSIF) also conducted research which showed 57 per cent of investors believed investment managers have a responsibility to ensure the companies they invest in on behalf of clients are managed in a ‘positive’ way.
Companies taking ESG seriously are long-term winners
Inequality and climate change have created a challenging backdrop for companies, meaning a failure to incorporate these principles will provide a poor return for investors.
This claim was made by Jessica Ground, global head of stewardship for Schroders, who said it was vital to think about environmental, sustainable and governance (ESG) investing in terms of “risk and return”.
“We see it as the third dimension of investing. If you are going to be successful in allocating capital on a forward-looking way, then you are going to need to take ESG into account, and to hold these companies to account.”
According to data from the S&P 500, the average tenure of a company has fallen from 50 years to 15. This means that companies operating with a view to long-term sustainability will be those who last the course.
Ms Ground added it was “so important” investors do not just use a tick-box approach to ESG. She said: "Investors should focus on digging into the numbers and on the material issues.
“For example, it is less important if a newspaper has a climate change policy, but it is very important that a mining company has one.
“Making sure you are focusing on the material issues and what the company is doing in practice is vital. To do ESG well in a way that helps investment returns, you have to be prepared to do fundamental analysis.”
Ms Ground, who has more than 20 years' experience of investing, said it was clear firms operating on strong ESG principles make better long-term holdings.
“I know for a fact that companies which are managing these risks well do make better long-term investments,” she added.
This is as important for individual investors as it is for institutional investors, but at any level, engagement is crucial to help drive change, she said.
Ms Ground also told FTAdviser that Schroders is focusing in particular on seven of the 17 UN Sustainable Development Goals (SDGs), which are being implemented by 2030.
“For example, one of the goals is on bribery and corruption. We have been doing a lot of work globally to make sure the companies in which we invest have robust [anti-bribery and corruption] policies and are monitoring their business behaviour.
“We have a huge role to play in policy and encouraging better practices.”
Ms Ground added it was important to know one cannot solve all 17 of the problems highlighted by the UN's SDGs, but by focusing on a few, she said “we can hope to move the needle”.
Inflows into socially responsible and ethical investment vehicles have increased substantially in recent years, with the number of funds with an SRI component also growing exponentially.
The Investment Association reports net retail sales of ethical funds hitting £807m in 2016, a record high.
Meanwhile, IHS Markit’s ETF analytics database recorded a total of $950m invested into SRI ETFs in 2016, and this year is set to be even stronger, with inflows of $800m already by the end of July 2017.
These figures are backed up by the annual Schroders Global Investor Study, which found that 54 per cent of UK investors have increased their allocation to sustainable investment funds compared with five years ago.
Meanwhile, 67 per cent of UK respondents report that sustainable investing was more important to them now than it was five years ago, with a significant proportion citing the potential for long-term returns as a greater factor than ethical considerations.
Over half, when asked to choose a phrase they associate with sustainable investment, selected something linked to profitability.
A report by Rathbone Greenbank Investments, the specialist ethical and sustainable investments team at Rathbones, demonstrates that the people they surveyed, on the whole, were looking for more than simply a good return from their investments.
Rather, they also wanted to either actively do good or, at the very least, avoid putting money into areas that would do harm, either environmentally or socially.
The report also showed the demographic of those interested in SRI and ethical investing was getting younger, with a relatively high proportion of wealthy millennials looking to align their finances more closely with their values.
“Our research shows that individuals more often want their values applied consistently across everything they are doing,” explains Matt Crossman, engagement manager at Rathbone Greenbank. “They place importance on authenticity and a sense of connection with the investments they are making.”
Tracking its evolution
With evidence demonstrating consistently strong growth in the sector, as well as the potential for strong future growth, it is valuable to consider how this style of investing has gained traction over the past decade, as well as how it has evolved over that period.
In essence, the main trends in socially-responsible investing have centred on three areas: the style of investments, the growth in the number of assets and investment performance.
“It is very easy for investors to get bogged down in the jargon and different terms applied to these types of investments,” explains Mike Appleby, an investment manager on the Sustainable Futures team at Liontrust Asset Management.
He says: “In general, when funds are described as ‘ethical’, it tends to be based on a negative screening process. They are generally defined by what they do not invest in, whether that is tobacco or weapons, for example.
“Another area is sustainable or socially-responsible themed funds, which look to gain exposure to areas benefitting from the phenomenal positive growth in the sustainability trend. Finally, there is active engagement, where the fund is actively seeking to encourage positive change.
“The overarching story is that the investment style has continued to evolve from avoidance strategies where the focus was on looking to avoid certain companies or areas, to a style of more positive involvement.”
He adds: “It is a win/win situation as it is possible to achieve competitive investment returns while also helping make the world a better place.”
Keep on moving
Amanda Young, head of responsible investment at Aberdeen Standard Investments agrees, stating that: “Until fairly recently, ethical investing was the main option if you wanted to invest to reflect your values, but the good money sector has moved along at pace in the last few years, with a range of options now available to investors.
“Where ethical investing seeks to exclude certain industries, such as tobacco and armaments, SRI funds look to invest in the most sustainable companies.
“Impact investing is the latest in the range, and involves investing with the intention to generate positive social and environmental impacts alongside financial returns.”
Meanwhile, for Andrew Howard, head of sustainable research at Schroders, a fundamental shift over the past decade has come from the replacement of the notion of socially responsible investment (SRI) with the more exact and descriptive environmental, social and governance (ESG).
Notably, this broadens out the options for investors far beyond those funds ascribed as “ethical”, encompassing instead the whole investment universe.
He says: “SRI has given way to ESG as the industry’s favoured term. It is a minor point, but it also reflects a wider recognition that environmental and social factors are not contained to SRI-labelled funds.
“The market has grown a great deal; it is very hard to find an investment manager who does not push their ESG commitment.”
Mr Howard continues: “This no doubt makes it difficult for fund investors. But it also puts the industry at a point where simply saying you look at ESG topics or run SRI funds is no longer enough.
“The question is turning from whether managers consider them, to how they look at ESG factors and the role that analysis plays in their investment decisions.
“Our own Global Investor Study highlights a growing recognition that ESG investing comes in different flavours with different goals.
“The market is maturing through an exciting shift where the attention turns from ESG as a generic idea, to the specific details of how different organisations and products are approaching the topic.”
Rathbones’ Mr Crossman also points to the increasing level of sophistication in products in this area, citing the growing demand among clients for the carbon footprint of their portfolio to be included alongside other key facts.
They also typically want comprehensive analysis of all of the screens applied, both positive and negative, to ensure the portfolio remains in line with their principles.
In addition, Ms Young sees a focus on more nuanced products that meet individual investors' needs.
She says: “Specifically at a product level, products continue to be launched that incorporate values into their construction.
“These include traditional ethically screened funds that avoid investing in companies in so-called ‘sin’ sectors such as defence or tobacco.
“Some funds take a thematic approach to sustainability issues, such as climate funds or water funds. In addition, fund choices reflect personal religious values, with various Christian or Sharia-based funds available to the consumer.”
She notes that, more recently, the social impact investment market has grown, which allows investors to direct their capital into social enterprises that will achieve both a financial and social return.
According to Ms Young: “This niche investment choice is slowly moving into the mainstream, with impact products that positively screen companies on their products or services, or select companies that have issued bonds to support social projects.
“Impact investing products are being considered and launched across a variety of asset classes.”
With almost as many options as investors, the question of whether it is necessary to sacrifice profit for principles is not straightforward.
Indeed, it is easy to see how UK equity income strategies, for example, with their traditional focus on the dividend-paying capacity of the mega-cap names, could suffer by excluding the giants in tobacco and oil and gas.
However, on the flipside, managers argue that stockpicking among companies that have a focus on environmental and social issues within their business often necessarily leads to firms with strong management and an element of future-proofing.
What is more, identifying companies that are well-placed to benefit from specific trends in sustainability can also help drive returns.
“Companies don’t operate in a vacuum; in the end, companies can’t succeed swimming against the tides in the societies they are part of,” says Schroders' Mr Howard.
“It is also very clear that we are in the middle of some major social changes and at the sharp point of acute environmental challenges. Identifying successful companies of the future means finding companies that are able to adapt and thrive.
“We are long term, fundamental investors and our commitment to environmental, social and governance issues reflects our understanding that traditional investment analysis and ESG research are inter-twined.”
Mr Howard also points out that some investors have goals beyond investment returns in isolation and, in those cases, different tools are needed.
"But it’s critical to design the ESG analysis we do to the goals we are trying to achieve", he adds.
A further question for advisers and their clients is whether it is better to opt for an actively managed fund or a tracker.
It is fair to say ETF SRI funds have proved popular and hold the same appeal as other passive vehicles, namely lower fees and index-linked performance, which is often stronger than active funds over time.
The indices are typically based on a parent index, which is then screened for positive and negative characteristics to create a SRI-friendly universe.
In this instance, it is crucial for investors to determine exactly what those screens are and how well they match up with their clients’ requirements.
Proponents of actively managed funds, however, argue that skilled qualitative analysis leads to strong returns.
Liontrust’s Mr Appleby, for example, states that it is integration between sustainability and general business fundamentals that is key.
Rather than looking for “the most lovely companies” from a values-based position, there is a need to refine that and look at the potential for long-term outperformance, he says.
Navigating the landscape
Overall, having gone through a period of rapid evolution, SRI does not necessarily offer advisers a clear landscape to navigate.
Victoria Hasler, head of research at Square Mile Consulting, which is tasked with providing ratings and analysis for a range of funds, points to the fact that it is almost impossible to rank one SRI or ethical fund as being “better” than another in terms of its moral integrity.
She stresses it is necessary to focus in on exactly what the client is looking for, their risk appetite and their performance objectives.
“Every investor has a line of things they think are acceptable and areas they definitely do not want to invest in,” she says.
“The difficulty is that line is different for everyone. In the work we do, ‘ethical’ funds have to meet the same standards as any other fund and are approached in the same way.
“We then provide additional qualitative information on all the funds we look at, covering any SRI or ESG credentials.
“It is up to the adviser and client in the end to find the fund that best meets all of their needs.”
Laura Mossman is a freelance financial journalist
The House View from Schroders
How attitudes are shifting on sustainability
Numerous surveys have shown that demand for sustainable investment is on the rise, thanks in large part to millennials.
But the investment industry has been poor at clarifying what “sustainability” means and what is being offered to clients in practice.
Instead, ever more terms are being thrown into the ring: ethical exclusions, green investing, impact... The list goes on.
What do clients think?
At Schroders, our approach to product development is
client-led, so we polled 22,000 investors in 30 countries to find out what they wanted in a sustainable investment fund.
The results were interesting and encouraging.
The most popular response from clients was that “sustainable investing” meant investing in companies that are proactive in preparing their businesses for environmental and social changes that may affect them in the future.
This resonates with our philosophy as active fund managers: we have always thought of sustainability as the durability of a business’s growth and returns, i.e. “what makes a great company stay great?”
More than a box-ticking exercise
Needless to say, the answer can’t be distilled into a single metric or company rating.
Ultimately, we believe that only companies that are run for the long-term, taking account of their impact on all stakeholders, will be able to sustain strong growth and returns.
Assessing the health of stakeholder relationships isn’t just about checking whether a company has a certain policy in place.
VW, for instance, had a whistleblower policy, which didn’t prevent the ‘dieselgate’ emissions scandal. What is required is a full analysis of a company’s culture and operations.
It’s about, for example, whether they can attract, retain and motivate the best talent, or embrace innovation that will enable them to adapt to a changing world.
We believe many of the sustainability products on the market today are too narrowly focused on a tick-box approach to ESG (environmental, social and governance) at the expense of fundamental analysis.
A “good” company – one that ticks all the ESG boxes – is not necessarily a good investment. It may not have strong growth prospects, a great competitive position, and returns above its cost of capital.
Alternatively, it may be a great business but with the positive characteristics already priced in by the market.
To our minds, this is why many mainstream ESG indices, which select companies based purely on ESG scores, have performed poorly.
It’s also why we don’t believe passive approaches are appropriate in this space.
We believe that consistently beating the market depends on combining in-depth sustainability analysis with rigorous fundamental research.
To this end, Schroders is taking a collaborative approach, combining the rigorous fundamental analysis and established investment process of our experienced Global Equities team with insight, research and experience from our Sustainability team.
Active ownership and ongoing engagement will also help to deliver long-term shareholder value: after all, there is no such thing as a perfect company.
Products must be fit for purpose
What is clear is that investors are more interested in sustainable investing than ever, with 78 per cent in our Global Investor Study stating that it has become more important to them over the past five years.
Younger investors are the most engaged, so as their wealth grows it is important that sustainable investment products are available to meet demand.
For products to be ‘fit for purpose’ they must be consistent with clients’ understanding of “sustainable investing”.
We believe that means investing in companies that are proactively positioning themselves for a rapidly changing world, and where we can deliver value by sharing in and helping to shape their future growth.
This is what we are seeking to achieve with the SISF Sustainable Growth Fund, a concentrated portfolio of companies we want to own for the long run.
Katherine Davidson is portfolio manager, global and international equities at Schroders