Sustainable investing - navigating a complex environment

The data problem

Data is also one of the largest challenges faced by the sector. To be able to make informed investment decisions, investors and managers require reliable and detailed ESG related information. Unless managers create their own extensive research capabilities to collect, analyse and monitor this data across the investment universe, there’ll always either be a limited focus, or some reliance on third parties. There are several research providers that aim to collect and make such data available, but a comparison between their findings, for almost any company, brings the challenge into sharp focus.

Royal Dutch Shell, one of the largest global oil and gas companies, receives a ‘high risk’ rating from one of the leading ESG research providers. Another provider makes industry specific comparisons leading to an AA ‘ESG leader’ rating for the same company. This is just one example, and part of the problem lies in the interpretation and analysis of data, rather than just its collection and presentation. However, unfortunately, inconsistencies and conflicting information are widespread in the industry. 

We aren’t yet at a place where companies worldwide and across all industries have enough of an incentive, or are required, to accurately record and disclose their ESG credentials. For some smaller companies, their sustainability may be considered inferior in comparison to larger, perhaps more questionable companies, purely as the latter has the ability to invest in provision of data. This murkiness, both at the company and research provider level, gives way to another of the industry’s current obstacles, ‘greenwashing’. In the current environment, it’s too easy for companies, funds, or investment solutions to portray themselves, intentionally or not, as greener, or more ethical than they truly are, and investors can struggle to distinguish between those that really are suitable for them and those that aren’t.

This is highlighted in the number of funds now investing in line with manufactured ESG indices. These can be widely used global indices, often adapted from a standard non-ESG index, designed to address the needs of sustainable investors while maintaining a broad universe to invest in. Investors could be forgiven for assuming that the ESG index, and therefore funds tracking it, was selective in its approach and had exposure only to companies with strong ESG credentials, notably improving the sustainability of their portfolio. However, many of these indices, and by extension, the funds tracking them, remain invested in up to 98% of the original holdings of the non-ESG parent index.

What's changing? 

With global changes in societal views, regulation, and attitudes towards investment, both the provision of data and credibility of sustainable investment solutions is constantly improving.

Societal change continues to move faster than policy. The Forum for Sustainable and Responsible Investment release reports on US Sustainable and Impact Investing Trends every two years. Their 2020 report found that one in every three dollars under professional management in the US was invested under sustainable investing strategies.  Today, increasingly, sustainable investors aren’t just concerned by the risk that holdings with poor ESG credentials may pose to their portfolios, but also what impact their investments are having on the wider world.

Changes to regulation are being made. The Task Force on Climate-Related Financial Disclosures (TCFD) was created in 2015 by the Financial Stability Board (FSB) and aims to globally develop more standardised disclosures to improve the quality of information available to stakeholders. In Europe, EU Taxonomy Regulation is targeted at providing common language usage and clarity in the industry. The European Commission’s Action Plan on Sustainable Finance has seen new legislative measures being introduced including the Sustainable Finance Disclosure Regulation (SFDR), the first level of which became effective earlier this year. In the UK, the government’s recent Green Finance Roadmap outlines proposed approaches to similar disclosure and taxonomy regulation. All these measures are attempting to address some of the reporting inconsistencies and scope for interpretation that are currently prevalent.

There have been criticisms of these measures that may also extend to the similar measures the UK government and Financial Conduct Authority (FCA) appear to be pursuing. Part of SFDR will result in funds effectively being grouped into different classifications of how sustainable they are. However, early indications are that the majority of funds with a sustainable aim will end up in the same classification, therefore any improvement in investor’s ability to make comparisons may be limited. Regulation is making steps in the right direction but doesn’t yet solve the issues.

Final thoughts

Improvements are continually being made, but until the consistency and accuracy of company and investment solution disclosures is more widespread, some investors will continue to be misled, and trust within sustainable investing will continue to be questioned.

With COP26 underway, it’ll be interesting to see if any commitments are made by global leaders that will result in further and more immediate strides in finance policy. As the world slowly moves towards greater sustainability, many more companies are likely to start meeting today’s definitions of suitability for ESG investing. This may increase the risk of traditional investment as the cost of changes in business practices cause those companies lagging to suffer. It may also, to maintain sustainable investing as a sector, push the envelope of what is considered to be sustainable.