The sustainability landscape

Investors increasingly want their capital to have a positive impact on the people and the planet, as well as delivering on their financial goals. Square Mile Research looks at how advisers can approach Responsible investment with their clients.

The green revolution is underway. It is impossible to ignore the demands for action on climate change from popular pressure groups, and the ever more ambitious targets for achieving net zero carbon emissions being published by governments worldwide. At the same time, companies’ supply chains are being scrutinised for any evidence of malpractice, while movements such as Black Lives Matter underline social injustices and the need for a more equitable world.

These calls for responsible capitalism are echoed across the asset management industry. Until recently, the primary focus for many investors was to ensure that the return on their investments met their financial goals. Today, of equal importance for many is the desire for their money to have a positive impact on both the planet and wider society. It is now clear those two goals are not mutually exclusive, and those businesses which are on the wrong side of the transition to a better world may well struggle as ESG and Responsible investment become increasingly adopted by fund managers across the industry.

Navigating this new landscape of Responsible investment may appear challenging; however, it presents a significant opportunity for advisers. Research conducted by Square Mile earlier this year, found that 41.7% of advisers surveyed indicated that over half of their new clients will seek to invest in responsible or sustainable strategies within the next three years. However, it’s not only investors and asset managers driving this change, but the regulator has also turned its focus to Responsible investment.

Although the UK is no longer obliged to adhere to the EU’s MiFID regulations, which require European advisers to ascertain and account for their clients’ sustainability preferences; the Treasury has opened a review of the EU’s ‘green regulations’. This is with a view to preparing recommendations to introduce a comparable regime in the UK.

While there are currently no firm timescales as to when any regulatory changes will be implemented or an indication to their extent, the direction of travel remains apparent. Therefore, it would be prudent for advisers to start preparing their business to understand and interpret their clients’ preferences towards Responsible investment. Furthermore, this extends to ensuring they have provisions for these preferences within their Centralised Investment Propositions (CIP).

A fundamental first step is to address any confusion surrounding the terminology used, as this will provide a solid foundation to build upon with clients. Historically, ‘ESG’ and ‘Responsible investment’ have been used interchangeably; however, there is an important distinction between the two. ESG should be viewed as an input into the investment process; a lens that a fund manager can use to determine the level of attraction of a stock and as a means of mitigating risk. It can also provide an indication of how a company’s ESG credentials might act as a tail or headwind to its future success.

Responsible investment, on the other hand, is an umbrella term that captures the spectrum of differing investment approaches which focus on using investment as a force for positive change. Commonly referred to as the Spectrum of Capital, these approaches range from those that exclude certain securities or sectors, to those that focus on delivering positive and measurable impact to both society and the environment. At Square Mile, we believe there are four broad categories which stem from Responsible investment, outlined below:

• Ethical exclusions which seek to avoid industries and company practices that cause harm to people or the planet.

For example, avoiding business which produce or distribute fossil fuels. • Responsible practices which consider the operational practices of investee companies, support ‘best practice’ in their respective industries, and encourage them to improve their environmental and social performance. For example, businesses which actively seek to reduce their environmental impact of their operations. • Sustainable solutions which seek to invest in companies that provide solutions to social and environmental challenges and believe in the long-term financial benefits of doing so.

For example, companies that manufacture products which improve energy efficiency. • Impact investing is where money is put to play in making a measurable positive social or environmental impact, with the added requirement of evidencing this impact. For example, those companies addressing healthcare needs and reporting the impact of patients cared for.

The use of a consistent framework of terminology is a useful tool to articulate the various aspects and approaches to Responsible investment, as well as determining where a client’s preferences sit on this spectrum. Furthermore, this Spectrum of Capital is increasingly being used by fund groups to demonstrate where their products sit within the broad range of strategies available, therefore highlighting what clients can expect.

While addressing the language is key in understanding clients’ preferences, there is the additional responsibility for advisers to establish how these are interpreted and applied within their firms, and there are several ways in which this can be adopted. One option may be to offer a Responsible investment solution as a default, which would require a client to opt out of this stream if it is of no interest to them. However, this shift may be too dramatic, and a more incremental approach may be preferred, and perhaps more practical. It needn’t be complex, and the evolution of the fact-find process could be facilitated by the introduction of a few key questions to open a discussion. The diagram below demonstrates what this might look like in practice.

By introducing preliminary questions relating to Responsible investment preferences, client segmentation can be implemented along three broad lines. First, those clients with no interest in investing responsibly who can continue to be invested into traditional portfolios. Next, those clients who indicate they would like to see their investment used as a force for positive change when it comes to social and environmental themes will, in most cases, be happy to invest in a diversified portfolio of funds which have a clear mandate to invest across the Responsible investment spectrum. Finally, there are those clients who have specific values or requirements that will require greater consultation to determine the solutions that are best placed to meet their needs and convictions.

While the green revolution is underway and Responsible investment continues to be plastered over the walls of the investment industry, it is important to note that this is an ongoing journey. As such, advisers can take the more evolutionary path to fine-tuning their approach to Responsible investment and client communication. This new landscape offers an excellent opportunity for advisers to demonstrate the value they can add to their client relationships by listening to their preferences and translating them into appropriate options.

“Although the UK is no longer obliged to adhere to the EU’s MiFID regulations, which requires European advisers to ascertain and account for their clients’ sustainability preferences, the Treasury has opened a review of the EU’s ‘green regulations’. This is with a view to preparing recommendations to introduce a comparable regime in the UK.”

Initial Questions:

Do you wish to invest sustainably?

Secondary Questions:

Do you wish to match your specific values or ethics to your investments?

Tertiary Questions:

Questionnaire to assess client’s personal sustainability preferences Traditional Portfolios

Sustainable Portfolios

Exclusion

Excluding companies which have a negative impact on society and/or the environment Responsible

Support firms with better social and/or environmental practice Sustainable

Rewarding and encouraging positive change and leaders in sustainability Impact

Inclusion of entities which have a positive impact on society and/or the environment

HNW Clients

Bespoke Portfolios Transactional Clients

Multi Asset Solutions