By Richard Gillham, Financial Planner at Progeny and Nick Astley, Investment Manager at Progeny Asset Management.

Industry minds from all sectors are increasingly focused on plotting their path to net zero emissions by 2050, in line with the UK Government’s Net Zero Strategy published last year.

Investors have an important role to play in supporting the transition to a green economy and investing within an Environmental, Social, and Governance (ESG) framework has been the fastest-growing investment approach. Global sustainable fund assets have almost tripled in the past three years, reaching $2.77 trillion at the end of the first quarter of 2022, according to Morningstar data.

But what is needed to support the transition from the fastest growing investment segment to the one that is chosen most often?

In this article, an Investment Manager and a Financial Planner give their views on some of the challenges within their own sector that need to be overcome if ESG investing is to make the move into the mainstream.

Nick Astley – Investment Manager at Progeny Asset Management

ESG investing has come a long way in even the last three years. In 2019, not one respondent to a major BNP Paribas ESG survey envisaged a future whereby at least 75% of an investor’s portfolio would integrate ESG by 2021. Whereas by 2021, over a fifth of investors (22%)* integrated ESG into at least 75% of their portfolios.

This illustrates a rapid upward trajectory and it begs the question, will ESG investing soon become the norm? Despite demand skyrocketing in the past few years, there are a number of areas that need attention before I can envisage this happening, however.

Lack of international standards for ESG investments

The lack of an agreed international standard for measuring the validity of ESG investments is a key barrier. Currently, it’s very difficult for companies to manage the inconsistent sustainability standards, frameworks and metrics. We have companies scoring well when looking at one data provider and scoring badly with another data provider and we have some companies disclosing lots of information and others very little.

To move forward therefore, homogeneity, transparency and set regulation must be at the forefront. The formation of the International Sustainability Standards Board (ISSB) is a positive step forwards for example, in terms of enabling companies to report on ESG factors affecting their business in a more unified manner but data quality and consistency still remains a significant concern for the industry.

We are also starting to see regulatory bodies showing their teeth here, with BNY Mellon, DWS and Goldman Sachs all recently under the spotlight for ‘greenwashing’. This is vital, as in Schroders 2021 Institutional Investor Study, 59% of institutional investors cited greenwashing as the major challenge to sustainable investing.

The power of collective investor action

However, I believe the most influential driver of change will be investor sentiment, which can already be seen to be having a significant impact on how companies think about their activities, especially in relation to managing risk, having a fully integrated ESG approach and generating more sustainable long-term returns. For instance, last year, we saw Engine No. 1 shake the big oil industry and as a tiny hedge fund that owned just 0.02% of Exxon Mobil’s shares, they managed to gain an unthinkable 25% of the seats at the Board table, based largely on their activism in relation to reducing Exxon’s carbon footprint.

Another example is when Shell announced that it was planning to become a net-zero emissions energy business by 2050. This announcement on its own wasn’t enough and investors asked for tangible evidence this was a credible strategy, pushing Shell to set carbon targets over three-to-five years and then link the targets to executive pay, incentivising leadership on climate change from the top.

The collective action of all investors is what I believe will shape the future landscape and hopefully one where ESG investing is at the vanguard.

*BNP Paribas ESG Global Survey 2021

Richard Gillham – Financial Planner at Progeny

Interest in sustainable investment solutions from clients is increasing rapidly and is only likely to grow further post-COP26.

A key challenge however is that in the absence of an over-arching framework or current regulatory guidance, advisory firms are having to use their own discretion and judgement to decide how they will integrate ESG and responsible investment into their proposition. This includes how they incorporate clients’ sustainability preferences as part of the overall suitability process and explore if ESG investments should be considered as an appropriate recommendation. There is currently no timetable for implementing the forthcoming changes to MiFID II in relation to sustainability preferences in the UK for example, although it can be viewed as a significant sustainable regulation tailwind.

The importance of ESG education

A strong sustainability narrative is needed to enable clients to improve their understanding and knowledge of what is at stake.  Better sustainability education by advisers, via thought leadership, workshops and webinars, will therefore be a fundamental building block to enable and empower clients to make informed decisions about their investment choices.

Advisers must then have a clear ESG proposition to offer to their clients, however with no standardised description of what constitutes a green investment, the key is understanding a client’s values and expectations, as investors will all have differing perspectives of what sustainability means.

In my own experience, most clients are generalists who care about climate change and broader sustainability issues, but who care more about maximising returns in the context of their risk appetite. There will of course be those who want specialist fund advice e.g. multi-asset ESG or impact investing, who may need to access specialist advisers or DFMs.

Standardisation of climate related disclosures

Moving forward, the financial sector needs both quantity and quality in climate-related disclosures and standardisation to streamline the process and to avoid any confusion and potential greenwashing. However, the conundrum is that financial firms cannot wait for perfect methodologies to start their net-zero transformation, as they have a critical role to play in encouraging more sustainable behaviours and influencing and directing capital flows.

In my view ESG investing can and must go mainstream, but the right frameworks are urgently required to enable such a transformational shift in investment strategies.

Author Bio:

Richard Gillham

Richard joined Progeny for a new career in wealth management in January 2021, following more than 20 years in investment management, primarily with Legg Mason.

He was made a Managing Director at Legg Mason in 2010 and covered equity strategies as well as macro strategy for a diverse global client base. He was also responsible for leading a diverse team of investment specialists.

Richard has an expertise in sustainability having worked closely with firms that integrate sustainability factors and balance profit with purpose. He believes that the linkages between sustainability, the economy and the financial markets are stronger than ever following the health crisis.

Outside of work, Richard likes to spend a lot of time with his three teenage children. He is also interested in politics and investing in companies that have a positive social impact and can help the transition to a more sustainable economic growth model.

Nick Astley

Having joined Progeny Asset Management in 2017, Nick was named one of the three rising stars in the Wealth Management industry by Spears Wealth Manager Index in 2020.

His day to day roles include performing due diligence on securities and portfolio level analysis. His areas of interest include fixed interest and small cap equities.

Nick is working towards becoming a CFA Charterholder and graduated with a First Class Honors degree in Financial Economics from the University of Leicester.