Why the industry can’t afford to greenwash ESG funds

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The pandemic has raised interest in the environment and other social factors. Returns from sustainable funds in 2020 proved you don’t need to sacrifice returns to invest in doing better. But in an industry known for chasing trends, do firms run the risk of greenwashing their products and eroding investor trust?

Interest has surged in responsible investing and consequently funds of this nature have grown – in number and in size – over the past 12 months. Richard Romer-Lee, managing director of funds research house Square Mile, says UK fund flow data shows an uptick three times higher last year comparted to 2019. His own company’s research in Q4 2020 shows two-thirds of advisers reporting increased client interest in such funds; three-quarters believe their clients understand investing in ESG-related funds will not result in sacrificing returns.

It is this latter point Romer-Lee believes to be one of the reasons investors seem to be more openly embracing such funds. Over the past year, many such funds outpaced many of their more conventional peers, perhaps settling the question over whether investing with such mandates means expecting lower returns.

However, while John Porter, CIO of equities at Mellon¹, believes investing responsibly is an important trend, he argues the performance driver was somewhat distorted by the energy sector last year. Porter notes the dramatic underperformance of conventional energy stocks in 2020 weighed on many funds – whereas those more exposed to renewables, fared better. 

Porter cites traditional energy companies as an example of some of the challenges investment managers face in evaluating companies through an ESG lens. “Many investors have reduced or even eliminated energy from their portfolios. In a year like 2020 that decision helped performance look better but as the economy recovers and energy starts to lead the market, which is already starting to happen, will investors resist the short-term pressure to buy energy and keep up with the market?”

He believes such investors need to be disciplined and he is somewhat sceptical they can be in the face of rising returns. However, he does think it possible to be a thoughtful ESG investor and still have some exposure to sectors like energy.

Hanneke Smits, CEO at BNY Mellon Investment Management, believes interest in responsible investment has already gone beyond performance. She says that as part of the reaction to Covid, there has become a need on the part of investors to see their own personal values reflected in their portfolios.

Romer-Lee agrees: “It has taken people a long time to understand the importance and the rationale behind investing responsibly,” he says. “We now live in a world where we have to think more about how we behave, how we treat one another and certainly how we look after the planet and the environment in which we live.”

Romer-Lee says these days he hears from advisers that the conversations they are having with their clients regarding ESG are about tangible things – like clean energy, better supply chains, how companies treat their employees. End clients, he reports, are seeing this as more interesting than a discussion about financial ratios and the other ‘go-to’ metrics the industry usually promotes.

He adds: “There is a will among investors to do good alongside achieving their financial goals. The two are not unconnected. We know sustainable businesses are the ones that are going to last, that are going to relevant, to be appropriate and help solve the issues the world faces.”

Smits points out both the industry and the regulators are responding to this movement but points out there are significant hurdles. The main one she cites is the insufficient standardisation of reporting data across the industry but education remains important as well. “We all need to do our bit but we also need to be transparent – explaining how you do ESG, what does responsible investment mean and how you report on it.” 

If we don’t get this right, both Smits and Romer-Lee believe there is a risk of eroding investors’ trust. For Romer-Lee, the funds industry needs to be clear and articulate about what investors should expect from them and deliver to those expectations. Investment management is a fiercely competitive industry, he adds, but one where sometimes the focus is too much on what other groups are doing (or not doing) and not enough attention is on what the end customer wants. He sees this time and this area as a prime opportunity to get close to clients and earn their trust.

Smits believes investors are also going to want to see that the managers they entrust with their capital are holding themselves to the same standards they do the companies in their portfolios – and demonstrate it. That means, that, in addition to delivering investment performance, ensuring the values of an investment management company and its funds sync up with those of its clients is vital for the future. “What we do as BNY Mellon Investment Management from a climate change perspective or what targets we set for diversity and inclusion, matters,” she concludes.

¹ John Porter will become CIO equities at Newton later this year. This is part of a transition of the equity and multi-asset capabilities of Mellon Investments Corporation (Mellon), to Newton Investment Management, expected to complete in Q3 2021.  For more information please visit www.bnymellonim.com.

Important information:

The value of investments can fall. Investors may not get back the amount invested.

GE379838 EXP 29 June 2021

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