This is the second post detailing discussions from our September Investment Forum all about ESG, featuring guest expert speakers Mikkel Bates, Elizabeth Stuart, and Anastasia Georgiou. The topics discussed in this section included standarization (or lack thereof) between ratings systems, how advisers can better educate themselves and clients, global differences in ESG, and the impacts that coming regulations will have on how advisers approach ESG with clients.

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Do you think there will be an increase in standardization in ratings?

Declan McAndrew:

Just at the moment, there’s a lot of subjectivity and lack of standardization in terms of the ratings and just how much commonality do you think there will be going forward, obviously they’re not the silver bullet, they never are, but you can see how obviously yourselves and others have come at it from different angles about whether the actual framework of a company being run, or the outputs are the most important starting point. And how much do you think that has hampered some of the acceptance within the advisor piece? Because, you know, this is a new thing for many UK advisers in the retail space. Institutionally, it’s been there for many years. And just whether the EU framework, the taxonomy and the disclosure piece will actually have acceleration to that in terms of the UK market.

The different ratings systems can be confusing, but they also allow for different methods and strategies to be tried, and to keep up with the science as it advances. The tools are important but your own judgement and relationship with your client is still the most central thing, as there will never be a silver bullet.

Elizabeth Stuart:

Certainly one of the largest criticisms of the ratings world is that they’re not consistent and, everybody uses a different lexicon, different jargon, which is a totally fair criticism, I think. And it adds, in some cases, a lot of undue stress to something that is meant to be helpful. However, do we want to go down the route where everybody is looking in the same direction and we don’t have any difference of thought or different methodologies or different data being pulled in? We need that debate because I think what brings a different element in ESG, and this speaks to your point about the taxonomy bringing in a lot of that standardized data, but a lot of ESG is based in science, that environmental piece.

As the science is moving forward and as what we can do, pushes on, we have to keep up with that. We may end up with something that we’re quite happy with now, for example, carbon footprinting, we’re all quite happy with the GHD protocol. And everybody says, that’s the gold standard, but in 5 or 10 years time, what we can do, what we can measure, and how we can manipulate our technology, just may be completely different. Beyond that, we’re just always going to have to be moving forward. People will want to keep their competitive edge. People will want to create new things and drive on and offer innovative things to their clients.

What I always say is, these kinds of tools and products are just that– they’re tools. They’re something you can use to make your life a bit easier a bit quicker, but it’s not going to replace your judgment, your experience, your relationship with your client and having a discussion with them. It is just that it’s guiding you and giving you a way of getting into that data  and having some experts to speak to, but it’s certainly not going to just be about silver bullet. And I’m that is frustrating, my actual background is in earth science and environmental technology and if there was a silver bullet, we’d have solved climate change.

It’s important to educate yourself and be able to explain your interpretations to the clients and to help them understand what’s possible.

Declan McAndrew:

There’s much more onus on the advisers to actually do that education with clients, and actually say, this is what our interpretation of how things are. And I know that’s  probably the second part of the session, but actually from our own experience, this is key. There is a reputational piece as well here, but you’ve got to stand behind the definitions, because those terms are being used in very different ways by different rating agencies, by different companies, et cetera. So I think if you do the groundwork that is actually a very useful exercise that manages expectations of the client, of what can, and of course what can’t be achieved.

ESG is a very unhelpful term. Many funds have lots of different investments in them with different ESG factors, so how are we supposed sort that out efficiently for clients?

Adam Smith:

It’s really interesting. Just tying a couple of bits that have been said already. It’s the separation between subjectivity and objectivity as to what comes through. And I think Mik’s comment about the fact ESG, I think it’s the most unhelpful term on earth, and as it industry we should be looking at moving away from it. Because it doesn’t mean anything to anyone. The, G’s a bit of a joke, why you would invest in a poorly managed company is beyond me. But the other two, to give you a specific example and try and just ask to how we get through this is the question.

We were looking at a sustainable MPS yesterday. It had investment in prisons and secondly, it had an investment in a German military base. Now I think most clients would deem if they were investing in that sort of product they wouldn’t want to be investing in a military base. But the provider would obviously make that assessment and that was fine. But how the hell do we, as advisory businesses get round that without having to spend a hell of a lot of time on advising sort of a soft holding level, rather than just a fund level.

Each client will have a different view on what’s important to them, and different ratings all measure different things. Also some investments have some negative ESG impacts and some positive ones, and may be in a fund based on certain aspects.

Mikkel Bates:

You know, it’s a very fair question. And I think part of the problem is without stealing onto the second half of the session, there are as many different answers as there are clients’ personal values and that’s the whole, the whole point of it is that values-based investing is subjective. So each of your clients will have a different view. There’ve been a lot of articles over recent months about the inconsistency between ratings agencies and their methodologies and so on.

But I think none of them have actually said that any of their methodologies are wrong, they just measure different things. And then in relation to your comment about, you know, German prisons or different prisons and German military bases, there was an article about a fund that was supposed to be an environmental and positive impact fund that invested in Manchester airport.

And there were a lot of questions asked on “why Manchester airport?” Because surely the aviation industry is negative, but Manchester airport has a positive policy for employment of under-privileged or people from disadvantaged backgrounds. So that, actually, it was a positive for it. And therefore for that reason, Manchester airport was in that portfolio. Now there may well be similar reasons, I don’t know, for the prison and the German military base. But the important thing is to understand the methodology and the only way you’re going to understand the methodology for a particular rating is if those ratings are clear and well explained.

I don’t subscribe to the argument that all the ratings should be like the credit ratings from Fitch and Moody’s and S and P and be identical, because there is no one size fits all answer for ESG. And I agree with you. I fall into a trap of calling it ESG because three letters is better than the 14 letters of sustainability, but I prefer sustainability as a term myself.

It’s important to understand the difference between impact and sustainability, and I get nervous about broad sustainable solutions because you’re trading on client preference.

Adam Smith:

I think it’s one of those bits that I still struggle with is educating our adviser about the difference between impact and sustainability, because I think you’re absolutely right that where it’s an impact solution, you can make that Manchester Airport argument, and we’ve got a solution which utilizes Heathrow investment on the same basis of this positive sort of social impact. I think it’s the difference between what an impact solution and what a broad sustainability solution is because it’s those broad, sustainable solutions I just get really, really nervous about because you are trading on that fundamental client preference.

There are ways for a company to become technically “sustainable” through actions that have absolutely no environmental impact.

Mikkel Bates:

Well,  there is a greater obligation on American management houses for that they have a fiduciary responsibility to maximize the financial returns for their investors. And that is a valid concern. I don’t know where America is going to go, but if they’re going to adopt it or not, I think a lot will depend on who wins the election in November. If there is a clear winner and if the election result is accepted, but if they choose to adopt an ESG sustainability, responsible investments approach there will need to be some changes to this fiduciary responsibility that that managers have on behalf of their clients.

There was a big article in the Sunday Times, a couple of weeks ago about BP and its great plans to go green by selling $25 billion of fossil fuel assets in order to invest $5 billion a year more into into green issues. The editorial in the Sunday times said, for BP to sell $25 billion of fossil fuel assets, someone has got to buy it. And if someone buys it, they’re not going to spend 25 billion on assets if they’re not going to make it work. And it’s more likely to be an American company that buys them than anyone else, probably, and you know, so from BP’s point of view, that’s great. They become a more sustainable company.  From a global environmental point of view, it has absolutely no impact on output at all.

There are already quite a few cultural differences in ESG behaviour, such as American asset managers tend to look more at national issues and European asset managers often look more globally. But until we can lessen fiduciary duty or ESG gains more traction in the market, political changes may not matter.

Elizabeth Stuart:

We can only speculate at this point until we see what happens in November and maybe a couple of Biden years might get us all a bit more aligned, but we do already see quite differences in ESG behavior, of American asset managers and European ones, even in the issues that they target in their stewardship or active ownership. We’ll see Americans targeting internal issues like the opioid crisis or guns and we’ll see European asset managers looking more global, they’ll look at climate change, palm oil access to water and water scarce areas and things like that. We do see those cultural differences a little bit.

Anyway. The current president has different views on a lot of things and he might further embed those. But until you see that a vice grip of fiduciary duty lifting, or until ESG funds gain a little bit more time in the market, a better track record, we can put a mix of underperformance or mix of under performance to bed, then it may become a moot point.

The best thing you can do is understand what your clients’ values are and what they mean. It’s going to take time before the regulators can get transparency of funds in front of clients so they can choose what they like. January 2022, advisers will have to disclose information on underlying investments, but that’s the same time that the underlying companies will have to disclose information as well. It’s very disjointed and rushed currently.

Mikkel Bates:

From a client servicing point of view, probably one of the best things they can do is get a better understanding of what their clients’ values are and what they mean. Again, I don’t want to break into the second half of the meeting and it’s going turn into a very short session if we do that. But I think trying to get clarity on the terminology and trying to get clarity on what their clients’ expectations are. Because that is the whole thing behind the regulation that the regulators are trying to get transparency of investment funds and portfolios in front of clients.

So the clients can say, “I like what that’s doing. That’s the sort of thing I want. I want a fund that is sustainable, that discloses this information”, and they can pick and choose from hopefully by then a wide variety of similar funds. But you will not get that, certainly in the first couple of years, unless you know what your clients actually want out of their investments.

And there’s no point in saying to a client, “do you want to consider ESG in your investments?”, Which is basically what you’re being told to do and that being the start of the conversation, because it’ll be a long conversation, it won’t be an overnight solution because you need to know what their values are. You need to find the solutions to meet those, to satisfy those values, and you will need the information and that information won’t be forthcoming really. Other than, currently, those funds that call themselves sustainable or ethical or responsible or ESG funds don’t provide that information and will most likely not be able to provide an awful lot of information for quite a while.

Under the taxonomy regulation, you know, you’re going to have to disclose information from January 2022 on the underlying investments, in the funds and so on. But January 2022 is the same point at which the underlying companies need to start disclosing information so that there’s going to be this big dichotomy.

So take your question back one stage to the investment companies, the fund groups, what they need to do, and what they’re being told to do by the regulators already is, “you’ve got this obligation in 2022. You may not get the information out the companies for another year, but we’re giving you more than a year’s notice. You need to engage with the underlying investee companies now to try and get that information in advance”. So this is what I was saying about it being very disjointed and very rushed in that they’ve got these timetables and they’re actually asking companies and everyone in the investment chain to ignore those and try and see what they can do to work around them.

It’s never too soon to take into account the level of disclosure coming from companies. But as they don’t need to disclose anything yet, they may not have the information yet and the templates they need aren’t ready. Every company now has a head of sustainable investment and are making the efforts they can.

Mikkel Bates:

It’s never too soon to do that. I think I wouldn’t be very popular among the fund industry, if I said, “yes, you know, steer clear of companies that don’t disclose anything yet” because they don’t have to disclose anything yet. And a lot of them are having trouble getting information or even understanding what they need to disclose.

The templates coming out of the disclosure regulation, they won’t be ready. Only one of them is ready. The others are not ready and they won’t be ready for some time yet. And so you’re having to work very much in the dark here, but most companies, are making the efforts they can. I mean, gone are the days when a compliance officer or compliance was the most valued role in a fund management company. Every company now has a head of sustainable investments and I’ve not seen any company not employ a head of sustainable investment in the last year, really.

At this point, it’s important to understand the data and more technical elements, to know what’s a good or bad score and what the rules and global agreements are so when the data comes out, you can understand and explain it.

Elizabeth Stuart:

I mean, things to do now, I think what would be really useful for all of the firms, because when the data comes, it will just be that– it will be data. It won’t be benchmarked or put into context, you’ll get these raw metrics and you’ll have to know, is this a good score? Is this a bad score? And when you’re explaining that to clients, you’ll need to be arming yourself with an idea of, “okay, what is the time horizon to the Paris agreement and why they were off shore? Is this a reasonable carbon footprint for a company like this? Or is it not?”

So that some of that technical knowledge of the core tenants of ESG will really help when you’re having to explain yourself and having to walk a client through their choices, because no one knows these things and we skip over the terms like a carbon footprint. Does anyone know if I told you the carbon footprint of Morningstar? Would you know if it was high or if it was low? So those kinds of technical elements.

I think to brush up on those to give yourself a little bit more of a deeper bench when having these conversations is a really good time to do that now. So when the data does come, you can get ahead of it and get control of it and be in front of it and explaining that to people.

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