Written by Paul Kelly
Inconsistent data and definitions make doing your homework essential.
Public awareness of global social injustice and the effects of climate change have increased significantly since Covid first wrought its chaos on the world, bringing with them a growing appetite for and availability of ESG-labelled investment products. Equity portfolios, fixed income and money markets have all entered the ring and the passive investment space is starting to muscle in on the active market. With investment opportunities growing by the day, how can stakeholders sort authentic prospects from unethical or irresponsible options?
Hunger for ESG-focused investments is insatiable currently. At 2020’s close, around $38tr in assets under management carried the label, up 24% from 2018, and assets look on track to grow to more than $53tr globally by 2025. Consumers and investors have started applying pressure on companies to demonstrate their ESG credentials at board level, through the products and services they offer and by way of their financing. They want to fund organisations whose activities have a positive impact. And they want proof.
There lies the problem; a lack of consistent definitions, reporting obligations, data clarity and ratings standards globally means that investors’ money may wind up in the very industries they wish to avoid. How ethical is tobacco? Does fossil fuel belong in the ESG space? Multiple different regulatory and governmental bodies have implemented or are considering agreed standards. The EU issued its Sustainable Finance Disclosure Regulation (SFDR) in March this year and the FCA recently published an open letter to authorised fund managers setting out its sustainable investment guiding principles, this in response to the many poorly drafted, unclear applications it’s received whose goals lack clarity: “They often contain claims that do not bear scrutiny.” Add to these the work being done by the Treasury Committee, the Task Force on Climate-Related Financial Disclosures and numerous other interested bodies across the globe and the lack of uniformity is glaring.
When Europe tightened ESG labelling in 2020 with its ‘green list’, ESG investments dropped by $2tr compared to 2018 even after new issues were considered. And, we need to bear in mind there are three elements to ESG. Does each factor need to comply with a minimum acceptable standard individually or can great performance in one offset infringements elsewhere? Take Phillip Morris; it sells 700 billion cigarettes annually yet is rated best in class according to the Dow Jones Sustainability Index North America. Its superior employee benefits, board-level diversity and responsible farming trump the damage its product causes.
The absence of agreed definitions leads to varying interpretations. In turn, this results in investors’ money funding activities most would struggle to deem ethical, responsible or democratic. Matt Orsagh, Senior Director of Capital Markets Policy at the Chartered Financial Analyst Institute says, “There is no agreed-upon definition of what ESG means, so funds may be marketing something that may not be in line with what a client wants.”
Investment funds claiming to abide by ESG principles are the fastest growing segment of the European funds market. In June £78.2bn was under management compared with £39.9bn in June 2020. An index tracker that invests in emerging market government bonds, the £240m iShares JP Morgan ESG EM Bond ETF, excludes controversial sectors such as tobacco, thermal coal and weapons. Yet it has a small (0.44%) exposure to Belarus, a country called on to end human rights violations by the UN last December (The Times, paywall.)
Even a company like Apple whose data is manifold and comparatively transparent compared with some private concerns can generate disagreement over its ESG credentials. The absence of standardised rating criteria globally produces vastly different scores; while Refinitiv rates Apple 73 and positions it 12th of all companies in its industry, Standard and Poor’s gives it 29/100 and places it third from bottom.
The variations in ratings and accountabilities and divergent interpretations of definitions mean anyone wishing to put their money where their convictions guide them must read the label carefully before investing. Myron Jobson, personal finance campaigner at investment platform ‘Interactive Investor’, says: “For investors wedded to investing in a way that closely aligns with their moral compass, there is no substitute for doing the legwork themselves. This means looking under the bonnet of every product purporting ESG credentials to ensure compatibility.”