The Five Wealth response to Sustainable Investment evolution
The recent FCA guidance on Environmental, Social and Governance ‘ESG’ funds comes amidst an intensification of activity in the fund management industry to assert the ESG qualities within their fund range. This in large part stems from a strong growth of interest and demand from investors, who want to explore ways to make a positive contribution to society through their investment strategies. It has also been driven by asset manager requirements to comply with the EU’s Sustainable Finance Disclosure Regulation (SFDR) where they are operating in the EU. The SFDR requires robust ESG disclosure and reporting from fund providers. As a result, it has been clear over the past year that the industry is moving towards a future where ESG factors are front and centre in their propositions and they are increasingly focused on demonstrating their commitment to integrating ESG factors in their processes. In some ways this has muddied the waters as on face value it is now less obvious which strategies are mandated to invest only within an ESG framework, which funds are simply considering those factors as part of their research process, which are actively engaging with company management on ESG factors, and which appear to be labelling themselves as ESG funds where there is a less than robust ESG research process in place.

ESG investment is not new, what has changed?

ESG investing is certainly not a new phenomenon, but fund providers are now much more vocal in demonstrating their ESG investment credentials. This has always been part of the promotion of funds with an ESG related objective but what is new is the active promotion of how ESG is integrated into research processes and shareholder engagement of those funds without a specific ESG investment objective. This has long been part of many strategies, particularly those with a quality focus but because it was not the main driver of investment decision making, it was perhaps not highlighted so much to investors. However, with the industry now pushing the ESG aspect of their products, front and centre, it is important to distinguish funds with an ESG objective, from those funds with an ESG integrated investment process.

ESG should form part of all fund due diligence

This emphasises the importance of fund due diligence to ensure that we understand how ESG factors are incorporated in an investment process and how important they are in driving investment decision making. There is no right or wrong way to integrate ESG in a fund process or objective, but a clear understanding is essential in aiding our decision making about how a particular fund may or may not be used to meet a client’s objectives.

The latest FCA publication is a step towards providing clarity on what is obviously a trending theme. This can only be a positive step in what we believe will be a permanent change to the fund management industry.

What is the FCA view?

The FCA has recently released their ‘ESG & sustainable investment principles’ with the aim of improving quality and clarity in the fund management industry. In particular, these principles relate to the design, delivery, and disclosures of ESG and sustainable investment funds.

They suggest that they have received a high volume of applications for sustainable investment funds but have been disappointed with the overall quality of these proposals, as often they do not contain sufficient, clear information explaining their chosen strategy and how this relates to the assets selected for the fund.

The guiding principles relate only to FCA authorised investment funds which pursue a responsible or sustainable investment strategy and claims to pursue sustainability characteristics, themes, or outcomes.

They do not relate to those funds that integrate ESG considerations into mainstream investment processes.

However, I think an important outcome of this review, will be that the lines should become less blurred, and it will be easier to determine the ESG credentials of a fund.

The guiding principles

The principles that the FCA hopes will drive improvements in the quality of ESG can be summarised as follows:

• Firstly, there is an overarching principle which states that ESG/sustainability should be reflected consistently in the fund’s name, stated objectives, investment process and strategy, as well as its holdings.
• The underlying principles state that an ESG fund’s name, promotions or documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
• The second underlying principle concerns the delivery of ESG investment funds and ongoing monitoring of holdings. This states that a firm should apply appropriate resources in aiming to meet a fund’s stated ESG objectives. In addition, a fund’s ESG implementation and its underlying holdings should be consistent with the disclosed objectives.
• The final underlying principle states that initial and ongoing fund disclosures should be clear, concise, understandable, and readily available to consumers and contain information that helps them make investment decisions.

We expect this investment theme to be subject to further regulatory scrutiny in the coming months and years, but we believe that this is a positive step in improving the quality and clarity around ESG investing and ultimately in improving client outcomes.

What does this mean for Five Wealth clients?

At Five Wealth we help clients to invest across a wide spectrum of investment strategies, both ESG focused and mainstream. For a number of years, we have been intensifying our research in this maturing investment theme, in order to build a strong panel of recommended ESG strategies. For those funds with an ESG objective, these principles provide a supporting framework to our existing fund research and due diligence. They will enable us to direct our research to these key identified areas and challenge fund managers to demonstrate how they meet the guiding principles.

As we look to the future, we will continue to refine and develop our investment research process to address this increasingly important aspect of investment markets.

Your capital is at risk. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested.