While we wait for the FCA and others to produce responsible investing definitions, Jonathan Ditchfield offers his own for five key terms.
In the midst of a general election campaign, we are reminded every day that language matters. There is great resource spent, to give just two examples, on whether one calls a second referendum on EU membership a "People’s Vote", and on whether to call the Benn Act to stop a no-deal Brexit a "Surrender Bill".
And language matters when it comes to responsible investment too.
Individuals in the UK now have access to over 120 funds, from most major fund houses, that are badged green, ethical, sustainable, ESG (environmental, social, governance), SRI (socially responsible investment) or impactful to some extent. However, there is a great deal of confusion over exactly what many of these terms actually mean.
Land of confusion
Research by Good Money Week last month found that over half of Brits (53%) do not know where their pension is being invested, and a similar proportion (52%) don’t know that their pension manager’s investment choices can have an impact on climate change.
The term "sustainable" now appears in the title of numerous investment funds, but there is little agreement on exactly what a "sustainable" financial product looks like.
Does it mean the fund invests in companies with robust business models? Or is the fund investing to solve key sustainability challenges such as the shift away from fossil fuels? Currently there are many different definitions in the market; for example some energy investors categorise natural gas or nuclear assets as sustainable, and others do not.
Complex concepts such as ESG – i.e. the integration of environmental, social and governance factors into stock selection - sound quite simple, but the portfolios that result are often a long way from what an ethically or environmentally minded individual would expect such a fund to be doing with their money.
Add to this the intense competition between fund houses to promote their own approaches to this space and it is not surprising that many individuals feel bewildered by the language being used.
A sustainable taxonomy is needed
It is time for the regulating bodies, including the EU and the FCA, to step in and help clarify the position. As it stands, there is significant risk that people are buying investment products that do not correspond to their expectations, leading to accusations of greenwash and even mis-selling.
The good news here is that the EU is progressing a 'sustainable finance taxonomy' that aims to create a universal language for investors and individuals to clarify which investments can correctly be described as green or sustainable. So just as the introduction of the metric system in the 18th century helped clarify the unworkable system of having different units of measurement within and between countries, hopefully the taxonomy will unite the market behind common definitions.
There are clear murmurings from the FCA that it is considering something similar, and the Investment Association has recently introduced an industry-wide framework of terms and categories for sustainable/responsible investment products too.
But setting industry standards on language is a hard task! And the bad news is that the EU recently decided to postpone the application of its sustainable finance ‘taxonomy’ by two years, until the end of 2022.
Education, education, education
Regulation and a common language are key, but individuals should expect more from their fund managers and financial advisers too. The financial services industry has got away with failing to give out full and transparent information on investment products for too long.
This has to end. Fund houses should be providing and detailed information on all their products and investment strategies (not just the top five holdings!) and all investors should expect their financial adviser to help them fully understand the products they recommend.
The goal should be that all individuals who want to make money and a difference should have easy access to clear and reliable information on every product labelled as sustainable, ethical, impact or ESG.
Busting the jargon… for now
We all know that when it comes to climate change and other environmental issues there is no time to waste. So while the EU and FCA are busy coming up with their definitions, here is my simple jargon buster for five key terms vital to understanding the sustainable funds industry:
- Sustainability – This is a commonly used word to describe any number of products or practices, but it is important to be clear about our interpretation of what sustainability really is. For my team at Impact Lens, it is the ability to meet the needs of the present without compromising the ability of future generations to meet their needs.
- Ethical Investing – This is a traditional form of responsible investment whereby contentious industries (such as fossil fuels or tobacco) are avoided.
- ESG - Stands for Environmental, Social and Governance. Analysis of risks associated with these three areas is often a central part of responsible investment. ESG risks can be integrated into the financial evaluation of a potential fund holding or can be used an overlay to decide which stocks can or can’t be bought.
- Impact Investing - Funds in this category will look to produce a measurable positive social or environmental impact.
- Responsible Investing – A catch all term encompassing all investment strategies that go beyond analysis of traditional financial metrics to include considerations of ESG risks.
Whichever government gets in next month, let's hope there is support for much faster action to ensure clear and honest language in the responsible investment sector.
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