Responsible Investing Podcast: The New Normal

26 November 2020

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Listen to our latest podcast with FT Adviser.

Lorna Blyth, Head of Investment Solutions joins Alan Chan, Chartered Financial Planner at IFS Wealth & Pensions and Gareth Mee, Sustainable Finance Consulting Partner at EY in our latest podcast with FT Adviser to discuss how to meet client expectations when it comes to ESG investing.

Imogen Tew

Hello, and welcome to the FTAdviser podcast, the podcast series brought to you by FTAdviser. This is a special edition sponsored by Royal London as part of the Responsible Investing: The New Normal series. ESG has become a key part of the asset management and personal finance world in recent years as investors have become increasingly conscious of the impact of their money. A recent paper commissioned by Royal London found that just 15 per cent of consumers thought companies’ positive actions were good enough, while more than 80 per cent believed brands were responsible for making positive changes in the world.

As popularity increases and further regulations surrounding responsible investing comes into play, what is in store for advisers when discussing such products with their clients? I’m Imogen Tew, reporter at FTAdviser, and joining me today to discuss the possibilities is Alan Chan, director at IFS Wealth and Pensions, Gareth Mee, a sustainable finance consulting partner at EY, and Lorna Blyth, head of investment solutions at Royal London. Welcome to you all and thanks very much for joining us.

So, in general, how quickly is investor sentiment changing on ESG and what is driving this? Lorna, maybe I’ll go to you on this, please.

 

Lorna Blyth

Yes, so we’re definitely seeing – I think there’s a broad move towards a requirement for more transparency from companies around their business practices. Some of that’s been accelerated by COVID and how businesses have responded to that. So, we saw particularly during the pandemic those that responded well in terms of how they looked after their employees or supported their local communities were the ones that were rewarded by shareholders and those that weren’t suffered in terms of share price.

I think that’s something that wouldn’t have necessarily happened five years ago so we’re definitely seeing a shift that’s translating into changing attitudes from customers. If I think about our own experience, I would say from last year it felt like this was going more mainstream. We saw an increase in the number of queries we were getting from advisers and from our policyholders in terms of understanding what they own.

They were asking specific questions about specific stocks, about specific sectors, so definitely seeing a change and a shift that’s increasing at pace.

 

Gareth Mee

Maybe just building on that, then, Lorna, I completely agree. I think investor sentiment is changing because these topics are so accessible. Everybody believes in something. Some people care about polar bears and the polar ice caps melting, some people care about fish and plastics, having spent time watching David Attenborough’s documentaries. Lots of people care about global warming, lots of people also care about equality in the workplace and so all of these are topics that people want to be able to vote for in the way that they invest.

 

Imogen Tew

Absolutely. Alan, as an adviser you have the most face time with clients here. What’s driving their interest in it, do you think?

 

Alan Chan

I have to agree. I think a lot of it is to do with just general societal shift. So, we’ve seen big, big changes to the way investors are looking to invest their money and a lot of it is more than just the financial gain, it’s also the responsible element of where their money’s going. On top of that, we’re also seeing a lot of changes driven by regulation as well. In addition to that, it’s increased media attention and documentaries like Gareth has alluded to as well, the David Attenborough Blue Planet II.

I think a lot of our guys have seen that, it’s about plastic pollution and it really hit home just how damaging plastic can be to our world and a lot of clients want to start to make changes and really pay more particular attention to where their money is going. I think a lot of that has driven behavioural changes and led to things like mass rejection to single-use plastic, plastic packaging, plastic straws. All those are a thing of the past, I think.

 

Imogen Tew

Yeah, absolutely. I guess that leads on to the potential pothole for advisers is how can advisers drill down to what investors actually want? It’s one thing to say you want to invest ethically but how can you translate that into an actual portfolio, Lorna?

 

Lorna Blyth

Yeah, I think from our perspective, we probably see two main customer segments and Alan can probably talk more to this but we see a growth in what we might call moral consumer behaviour or this growing desire to do the right thing. That’s a broader general shift around more transparency about what investors are holding and wanting to understand about how those companies – what they’re doing in terms of broader society and the impact they’re having. Our observation would be that that’s where the majority I think of clients will sit.

Then the other segment is those that are specifically looking to prioritise particular values in the way that Gareth talked about, polar bears or plastic, where you’re looking to prioritise those values potentially over financial return and the adviser’s role really there is to understand where do their clients sit on that sort of spectrum and how do they then translate that into a portfolio. That group might have specific areas they might want to exclude or alternatively positively focus on.

Of course, some of this feeds into the PROD framework and adviser-client segmentation and how they think about the different types of responsible investing, whether it’s exclusions or impact investing or ESG integration and which clients they have that might sit under each of those segments.

 

Imogen Tew

Sure. Alan, you may be good to come in here. How have you embedded ESG into your process as an adviser?

 

Alan Chan

So, right from the start we’d have the conversation with all new clients and existing clients [through their] review, so really to gauge their views on responsible investing and try to understand what it means to them. Because ethical investing is quite a nuanced phrase, it’s not uncommon to hear people say things – use the term ESG, ethical, sustainable all interchangeably in everyday speak and as we know, those terms refer to different ways of investing responsibly.

So, what we want to do is really understand exactly what they like and what they don’t like about ethical investing or traditional investing and help them meet their investment preferences. So, we run a centralised investment proposition, we’ve got seven portfolios, two of them are ethical ones, and within our traditional portfolios, the five that we already run, we’ve started taking into account ESG factors.

So, we look at analyst reports, for instance from Square Mile, which are very, very good, and when we’re reviewing funds and look at replacement funds, we start to pay more particular attention to ESG factors. So, something we’ve never done in the past that we’ve started to do within our processes and within our traditional portfolios is we’ve started to allocate about five to 10 per cent of the portfolio to ESG funds. So, still learning, still part of development.

I think as the whole industry goes through this whole evolution; I think we’re still learning best practices from other people as well. So, obviously on top of that we undertake relevant CPD in ESG and responsible investing, just because it is a market that’s constantly evolving and constantly changing and we just want to keep up to date with developments. So, we like to think that we’re making great strides in the ESG funds.

 

Gareth Mee

It’s really pleasing to hear you talk in that way, Alan, actually. It sounds like a really progressive way of thinking. If we think about the choices that customers had in the past, then it was primarily about excluding very large proportions of the financial universe and so back in the 90s, that might have been a drag on performance.

But the way that you were just talking there then, investors can express different preferences so if there’s something that they believe really strongly in, then they can go into an impact investment which will then help them to meet one of the sustainable development goals, or if there’s something they just want to tilt, then they can invest in something that’s a bit more overweight in some of the sectors or some of the topics that they really believe in.

Then many fund houses now will have a relatively small number of exclusions, so for example not many people think that it’s a good idea to invest in cluster munitions and so most people would exclude those, but in alcohol, tobacco, energy, people have got different views and so there aren’t really wholesale exclusions across those sectors where that perhaps more of the focus back in the 90s. 

 

Lorna Blyth

I think the point about education is really key. Sometimes when I speak to advisers, they’re quite worried about recommending funds that might seem to fit the client’s objectives and requirements but they’re worried that then a particular stock gets included in that fund and that upsets the client whereas actually, Alan, from what you’re saying – and Gareth – it isn’t just about excluding, it is about potentially tilting towards a fund that maybe represents their values or their preferences but it doesn’t necessarily need to be their whole portfolio. I think that’s quite an important point.

 

Alan Chan

Absolutely. Just to add to that, whenever we speak to a client around ESG or ethical investing in quotes, we start off by educating the clients around different types of responsible investing, so all the way through from ESG, ethical, sustainable to impact investing and talking to them about each type of responsible investing to gauge which one of those – maybe all of them or none of them at all – tick their boxes, in which case maybe it’s something we can’t help with.

It’s rare, but we do come across the very passionate ethical investors who will come to us and say, we don’t want investment in the big banks and we don’t want investment in oil and gas companies and hold very, very strict principles in that regard. What we try to educate them about is a lot of this is compromise, that there are no black and white companies when it comes to ethical investing and it’s a case of you come to a compromise, a balance between financial gain and meeting the ethical criteria.

So, a lot of that goes toward educating the client, making sure they understand what they’re getting into.

 

Imogen Tew

Yeah, absolutely. I guess one of the biggest challenges facing advisers in this remit as well is how do you balance what investors want versus what investors may need and how much does an adviser force the client’s hand here? Gareth, any thoughts on that?

 

Gareth Mee

I think this is hard both ways in terms of investors that need a high return, then they need to be able to potentially invest in a very wide set of investments and some of them might believe that they’ve got strong preferences like the ones that Alan just talked through but excluding large proportions of the portfolio could potentially be challenging. The investible universe could potentially be challenging.

We all love the idea of investing in purely renewable energy assets that will give us a guaranteed 10 per cent return but sadly, there aren’t loads of those types of opportunities out there and so this balance of investor need for something which is in line with their values, something which meets their return target, also diversification and availability of those assets, those are the sorts of challenges that they’ve got to try to balance. 

 

Imogen Tew

And at an okay cost, right? You’ve got to be thinking about the fees of the funds as well. Lorna, anything to add there at all?

 

Lorna Blyth

No, I think what Gareth said there I totally agree with. It is difficult but these are the sort of things that advisers are dealing with. This is their bread and butter, really. If you think about the client fact find, it’s not just a tick box exercise. If I think about risk profiling, for example, advisers will start with a set of questions and that will potentially put the client into a particular risk profile but then it’s about a conversation about what does that mean in terms of the return, the types of assets they [could access], the costs and in some ways, ESG profiling or capturing preferences is similar to that.

It’s a similar process, it’s about the conversation, it’s about understanding what’s really important to the customer and agreeing between the adviser and the client the right way to go.

 

Gareth Mee

The great news is that it’s no longer a choice. So, in the past, people used to think that you could make the choice between something that returns more or something which is responsibly invested and one of the things that the paper that we have just published, EY and Royal London together, is covering is that actually, ESG is a really good indicator of potential downside risk. It's a good lead indicator of credit risk in terms of downgrades and defaults.

Those companies that, for example, have not embedded good governance are more volatile and are potentially at higher risk of being – of downgrading and so this is now about good risk management, it’s not about giving up returns.

 

Imogen Tew

Sure. One of the reasons why ESG is tipped to become even more popular and more embedded in our personal finance culture is the amendment to MiFID II, which is meant to be coming into force early next year, where advisers are going to be required to ask their clients about their ESG preferences. One thing that some people who think of ESG as a fad say well, of course if you ask someone do you want to invest responsibly, they’re more likely going to say yes even if they a) hadn’t thought about it before, b) isn’t really embedded in their own actual wants and needs but you’ve asked them so they feel like they should say yes.

Sure. One of the reasons why ESG is tipped to become even more popular and more embedded in our personal finance culture is the amendment to MiFID II, which is meant to be coming into force early next year, where advisers are going to be required to ask their clients about their ESG preferences. One thing that some people who think of ESG as a fad say well, of course if you ask someone do you want to invest responsibly, they’re more likely going to say yes even if they a) hadn’t thought about it before, b) isn’t really embedded in their own actual wants and needs but you’ve asked them so they feel like they should say yes.

So, how do you make sure that an adviser isn’t influencing a client? Alan, how do you bring it up without feeling like you’re influencing a client’s choice here?

 

Alan Chan

As you’ve alluded to, phrasing of the question           is very important and it’s important not to – if you ask the wrong question, you’ll get the wrong answer sort of thing. So, really try to ask open questions and what we try to do is understand just how strongly they feel about certain issues like in quotes ethical investing. So, for instance, when we look at ESG, for instance – and I use the term ethical investing quite loosely there to cover all the aspects, so let’s look at ESG for instance.

Is it the E, the environment aspect that really concerns them, things like climate change or a company’s carbon footprint? Or is it the S, is the social factors, the human rights or the employee welfare side of things? Or could it be the corporate governance, do they take issue with director remunerations and the transparency and accountability of the company? So, really trying to gauge which of these areas that the client is looking for or have issues with and then go a bit deeper as well, so we take it a step further and find out why is that important to them.

That’s all part of the KYC, the know your client process, and the client may reveal that actually, they’ve been campaigning against animal testing all their lives and this is who they are and this is very, very fundamental to them and they want to also make sure their investments are aligned to this. That tells you a lot about the client and how you should be tackling this potential problem and designing this portfolio for the client, so it’s ask open questions and let the client speak and make no assumptions. Just let the client speak and really listen to what the client has to say around that.

 

Imogen Tew

Sure. Lorna, anything to add there? What do you think advisers should be doing in terms of their process to make sure they’re not leading their client down the wrong avenue?

 

Lorna Blyth

Yeah, so I agree with what Alan said there. I think it is starting with education, it’s about asking open questions, it’s about making sure that there’s a framework in place across the firm where the terminology’s really clear so we all know what we’re talking about when we say sustainable or ESG or ethical or responsible. What does that actually mean? What does that look like?

There’s a lot of support already out there for advisers in this space. If I think about even the last couple of weeks, the amount of ESG webinars that are available to educate and understand and help advisers put in place a framework and a process that means that they can embed this well into their existing processes.

 

Imogen Tew

Lovely. What preferences do investors tend to have when it comes to ESG investing? We obviously as an industry talk a lot about the environmental stuff, the climate change and particularly the kind of environmental side but is that something, Gareth, that investors are definitely leaning towards or is there other stuff that they’re bringing up as well?

 

Gareth Mee

I think we’ve got a real opportunity now to bring together a couple of potential challengers in the market. So, there’s understanding of ESG but also engagement in finances and wealth and you might have seen this Make My Money Matter movement, which is all about getting engagement around the £3 trillion pounds of the pension savings that we’ve got in the UK. The idea of this is that people generally do feel strongly about something like we talked about earlier on, polar bears, fish, et cetera, and so being able to turn that into something that they can do on their investment is really very powerful.

If you think about people wanting to express preferences on the way they eat, so we have more vegans, people wanting to express preferences in terms of the types of cars that they drive, but actually the biggest single thing that they can influence is their investment and their pension is a really big opportunity to do that. The second thing that I’d say is also people like real metrics.

So, tonnes of carbon dioxide saved is something that people aren’t really engaged with but what they can engage with is, if I switch from fund A to fund B, this is equivalent to taking 10 cars off the road or this is equivalent to removing landfill the size of Bolton. These are the sorts of metrics that people want to be able to engage with, things that they can actually tangibly understand. That’s something that I think’s really important in terms of being able to get them to engage with their pension.

 

Imogen Tew

Sure. Alan, what are you hearing from your clients? What are the most common ESG preferences that they bring up?

 

Alan Chan

Yeah, it’s an interesting question because our experience is that most investors are mostly concerned with the E, the environmental factors, and I think that’s the one that they hear about more and the one that they know of. So, things like sustainable infrastructure, renewable energy, reducing carbon emissions, plastic pollution and like I said, partly that’s brought about by increased media attention, documentaries, the David Attenborough show a couple of years back and it’s really brought that to the investors’ [unclear], just how much damage these issues are causing and actually, a lot of they can actually contribute to in a positive way.

So, we take that and that’s generally the starting point when we discuss it from the clients, understand where they’re coming from when they talk about ethical and it’s generally like I said starting from the environmental stuff and then that opens up the conversation to the rest of the package, what responsibly investing has to offer. There’s also the like I said social factors, the corporate governance factors, but also more the sustainable themes as well.

It could be investing in renewable energy sources or cleaner water resources around the world, so it’s really interesting to see and like I say, we’re starting to have more and more of those conversations with clients who come to us around ethical investing and it’s good to see that evolving very quickly.

 

Lorna Blyth

Actually, we carried out a program of research with about 2000 customers over the summer and as Alan said, environmental concerns were the single most important factors that came through, but actually we also saw issues such as fair wages, modern slavery policies starting to appear in the top five concerns that customers wanted addressed.

So, I think probably what we’ve seen as we emerge from COVID is that the S, the social aspect, is becoming stronger than it was previously, so I think that’s really interesting and it just highlights how this space evolves quite quickly and keeping to speed with all of that is really important in terms of giving advice to your clients.

 

Imogen Tew

Sure. Open question to all of you: how solid is this change in investor sentiment? As I mentioned previously, you do still have people that work on the ground in the industry that call it a fad, they say it’s something that’s going to come and go and we’ll be back to all sustainable funds closing down and all of that. Do you think investors will continue along this trend?

 

Gareth Mee

This is not a fad anymore. This is a solid change. I think if you look at the evidence of performance, some of the stuff we’ve talked about today, if you look at the demand from the consumers, the topics that Lorna just described, people care about these points, and if you look at the amount of regulation – 38 of the top 50 countries have now passed regulation which looks to embed ESG into all financial products, the convergence of those three topics just makes this unbreakable now. So, we’re going to continue to see this grow, not die away.

 

Alan Chan

I completely agree with Gareth’s sentiment there. I think it is not a fad. I think there is quite a clear underlying shift towards more responsible investing and people just generally becoming more conscious about this sort of thing. Coincidentally, we have seen these investments as well have been very resilient in recent times and in these very difficult times during the pandemic. Naturally, that would attract attention from all investors, not just ESG or ethical investors but all investors.

But I think it’s here to stay, in fact I believe it’s here to stay and I think in a couple of years’ time, we won’t be talking about traditional investing versus ESG investing. It will be fully embedded in a couple of years’ time, three, five years’ time, however long it takes, and it will just be the norm. It will just be called investing in general. We won’t be talking about the differences between the two anymore. 

 

Lorna Blyth

Yep, I totally agree. 

 

Imogen Tew

Alan, Lorna, Gareth, thank you so much for joining us. Thanks for listening to the FTAdviser podcast.

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