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the great divide

This article is the second in a series on the challenges and opportunities in environmental, social, and governance investing, and the great divisions in the investment industry on the attitudes to, and acceptance of, this rising trend.

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There are growing concerns about ESG products that contain companies such as petroleum majors and other large polluters to boost a fund’s performance.Rawpixel/iStockPhoto / Getty Images

The skyrocketing interest in responsible investing (RI) is posing a challenge for financial advisors: How to find the right investments for their clients while avoiding the growing concern of “greenwashing” that could backfire on results and harm their reputations.

The growth of RI is being driven by rising concerns about climate change and social movements demanding greater action on gender and racial diversity and inclusion. Growing evidence that these investments, which incorporate environmental, social, and governance factors (ESG), have also met or beat benchmarks has also played a major role in moving RI into the mainstream.

According to a recent analysis by Bloomberg Intelligence, global ESG assets under management (AUM) are on track to exceed US$53-trillion by 2025, or more than one-third of the US$140.5-trillion in projected total AUM. That’s up from about US$37.8-trillion in ESG AUM today.

Along with the rising number of products on the market are increased concerns about what products are receiving the RI or ESG label. The issue was highlighted in a recent USA Today opinion piece by Tariq Fancy, former chief investment officer of sustainable investing at BlackRock Inc., the world’s largest asset manager, accusing the financial services industry of “greenwashing” with its RI products.

Mr. Fancy wrote that RI “boils down to little more than marketing hype, [public relations] spin and disingenuous promises from the investment community.” He also pointed out some often-cited inconsistencies, including ESG products that contain “irresponsible companies such as petroleum majors and other large polluters like ‘fast fashion’ manufacturing to boost the fund’s performance.”

He’s among a growing number of investors and environmentalists who have pointed out the perceived paradox between what’s considered an ESG investment.

Why advisors need to be concerned

What constitutes an ‘RI’ product is important for advisors as more clients are paying closer attention to the kinds of companies and funds they’re invested in. According to the Responsible Investment Association’s (RIA) 2020 RIA Investor Opinion Survey of 1,000 Canadian investors, 72 per cent of investors said they are “very” or “somewhat” interested in RI, up from 60 per cent two years earlier; and, three-quarters want their advisors to tell them about RI that are aligned with their values.

It’s knowing and understanding clients’ values that advisors need to keep top of mind, says Dustyn Lanz, the RIA’s chief executive officer.

“When it comes to responsible investing, it’s not one-size-fits-all,” he says.

For instance, he says some ESG funds hold oil and gas companies to encourage emissions reductions through shareholder voting and dialogue, while others are fossil fuel-free. The various funds are set up to appeal to different types of investors with different definitions of RI.

“So, it does really require a little bit of research and exploration from advisors and investors,” Mr. Lanz says, adding that they should search RI information in fund prospectuses and Fund Facts documents.

“What’s important about these documents is they have regulatory requirements. They go through compliance departments before they’re published,” he says. “That matters because we’re talking about information that has gone through a rigorous internal review, as opposed to from the marketing team to the website.”

What to look for in an ESG fund?

A challenge for advisors and investors is that there’s no consistency in the language used for ESG investing, says Tim Nash, founder of Good Investing Financial Planners Ltd., a Toronto-based financial planning firm specializing in RI.

“There is a lot of confusion around the terminology and the way it’s communicated to investors,” he says. “When evaluating the different options, it’s important to understand what it means to the end investor. What does the client expect?”

Mr. Nash recommends advisors talk with clients about the various options, one of which is negative screening, or excluding companies or sectors such as fossil fuels, guns, and tobacco.

“Some investors will have an attitude that they don’t want one penny going toward certain companies or sectors, while others are comfortable with money invested in those companies or sectors provided ... you’re getting rid of the worst of the worst, and/or that there’s shareholder engagement – that their shares are voting to push that company in a more sustainable direction,” he says. “It’s important for advisors to have the conversation with their clients to understand where they are on these issues.”

The next move is to evaluate the products that could go into a client’s portfolio. That’s where advisors may look to research firms like Morningstar Inc., MSCI Inc., and others to see how they score certain companies and funds on ESG metrics. Mr. Nash is also a fan of the non-profit shareholder advocacy group As You Sow, which screens U.S. funds around areas such as fossil fuels, tobacco, and gender equality.

Ian Tam, director of investment research at Morningstar Canada, says his firm currently has about 156 funds in Canada that it considers sustainable. The Morningstar Sustainability Rating measures financially material ESG risks in a portfolio relative to its peer group.

Mr. Tam says advisors rely on research from firms like Morningstar Canada because there is no regulation in Canada that enforces RI reporting, making it hard for investors to know what they’re buying is truly sustainable.

“Right now in Canada ... there’s no standardized classification ... and nothing’s being enforced by regulation,” he says. “So, that really gives a lot of this freedom to find manufacturers to market their funds as they see fit.”

What is the investment industry doing?

In turn, some organizations and regulators are looking to address the inconsistencies in how ESG data are disclosed to investors.

For example, the CFA Institute is working on a global product disclosure standard. It’s currently seeking comments and feedback from the industry and stakeholders, such as CFA Societies Canada.

Michael Thom, managing director of CFA Societies Canada, says the voluntary global standard will be a strong start to help investors and the industry become more aligned on the communication of ESG features in investment products.

While he acknowledges it likely won’t satisfy all stakeholders, “someone has to start developing a common language … to provide greater product transparency and comparability.”

The Canadian Investment Funds Standard Committee (CIFSC), which classifies Canada’s mutual funds, is also working on a RI fund identification framework that would categorize funds based on their approach to RI, aligned with the CFA Institute’s standards.

“We want to bring a level of accountability to RI funds to make sure that funds marketed as RI are in fact doing what they say they’re doing,” says Reid Baker, the CIFSC’s chairman. “People want to see consistent definitions and themes across the industry. It doesn’t really serve anybody ... to have multiple different definitions or categories of RI.”

He says the time is now to come up with a framework given the growing number of ESG-labelled funds coming to market.

“We want to identify which RI approach a fund is using because I see a future in which it’s possible that we get to a point that every fund in Canada talks about ESG factors in their investment process,” Mr. Baker says. “So, we really want to have a standard, with some measurables, to identify the ones that are actually making a difference across ESG factors; otherwise, we just end up calling everything an RI fund. ... Ultimately, we want to make it as easy as possible for advisors, but also provide necessary details.”

Furthermore, fund managers, portfolio managers and exempt-market dealers involved in ESG investing are being targeted in a “green sweep” that the Ontario Securities Commission (OSC) and the B.C. Securities Commission (BCSC) are conducting.

The regulators are looking for information on ESG-related portfolio and fund management, compliance and marketing, and disclosure practices, according to Lynn McGrade, a partner at law firm Borden Ladner Gervais LLP who specializes in corporate law with a focus on investment management. She says misleading practices could lead to regulatory enforcement action and investor claims for misrepresentation.

Such “sweeps” tend to be the first move before new guidance is released and potentially new regulation, Ms. McGrade says.

“The fact that there’s a green sweep is showing that ESG is moving up to a very priority area for our Canadian securities regulators, and therefore for the registrants that they regulate,” she says.

Ms. McGrade points to the International Organization of Securities Commissions, which stated earlier this year that it sees “an urgent need to improve the consistency, comparability, and reliability of sustainability reporting,” starting with a focus on climate change-related risks and opportunities.

“Hopefully, that means advisors are going to get really much better-detailed information to help them advise their clients,” Ms. McGrade says.

In the meantime, she encourages advisors to follow the lead of regulators and look deeper at whether an RI meets their client’s own definition.

“Advisors can do a little bit of groundwork in the very same way and ask some similar questions,” she says.

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