Sustainable and Responsible (ESG) investment funds - what's really under the bonnet?
Thursday 1st June 2023
Katy Baxter
There's much talk these days about ESG in the investment world and as a new advisory business we wanted to be able to offer our clients a range of ESG funds when building their investment portfolios. We know that some clients have strong views on how their investments make the world a better place and this is borne out by recent figures which show that in 2022, UK investments in ESG funds reached a record £91 billion which was up from £56 billion two years earlier. So what do each of these factors actually mean:
Environmental factors
Natural world factors and the biosphere. Includes the interaction and use of renewable and non-renewable resources (ecosystems, biodiversity, water, minerals)
Examples of this are climate change, waste, pollution, deforestation, resource depletion.
Social factors
Issues that affect lives of humans, communities, and management of human resources.
Examples of this are employee relations, work conditions, human rights, child labour, human rights.
Governance factors
Factors involving the issues within business models and industry practices which may be of interest to broader stakeholder groups.
Examples of this are executive pay, bribery and corruption, board diversity.
As a firm we liaise closely with an external specialist in the ESG space and also follow reports produced by the FCA who have recently made it clear that they intend to clean up the ESG fund market. They feel there are funds who market themselves as ESG friendly but in reality do not follow ESG standards. We feel this is good news for investors.
Under the new rules, only 'true' ESG funds will be allowed to market themselves as such, so that investors are not being misled by what is termed as 'greenwashing'. The FCA are proposing that ESG funds will use three specific terms which are as follows:
· Sustainable focus funds will need to invest at least 70% of capital in companies or government bonds that meet a 'credible' threshold of environmental and/or social sustainability.
· Sustainable improver funds will have to clearly state in which areas they will and will not invest, and also outline their policies to influence for the better companies in which they own stock.
· Sustainable impact funds will be required to 'articulate a theory of change', and regularly keep investors informed about their performance in helping to drive such progress.
The FCA hope that these new descriptions will make it much clearer for investors as many remain confused about how funds are currently classified. Under these new rules the FCA will exclude funds who deviate from their stated aims which some commentators argue could exclude 60-70% of funds currently in the ESG sector.
No doubt some firms will decide to exit the sector if regulation tightens but many will continue to remain active accepting the fact that regulatory scrutiny will increase. The FCA's proposals are just one of many reforms the sector will undergo as the climate challenge heats up. At Montgomery Estate Planning we are supportive of these changes so that our existing and future clients clearly know the credentials of the ESG funds they choose to invest in. We will continue to work with external organisations so that our own panel of funds meets any new requirements from the FCA that are coming down the track.