Do you remember when you could smoke wherever you wanted? When you could take home your shopping in free plastic bags? Such unhealthy and unsustainable behaviours changed very quickly following the introduction of new regulations.
And we are set to see a similar, albeit more gradual, shift in the investment world as we move towards more sustainable investing.
European Union legislation, currently being finalised, is due next year. Designed to promote responsible investment, it should be welcomed by the growing number of people who want their savings and pensions invested in companies in the sustainable economy – those that are environmentally and socially responsible.
Under this new legislative framework, financial advisers will be obliged to ask clients about environmental, social and corporate governance (ESG) preferences and, for those who are interested, they will need to provide a sustainable investment option.
This is not designed merely to be a box-ticking exercise. And to prevent that, advisers will have to clearly document their process and be able to evidence why certain clients did not select the sustainable investment option.
The expectation is that this will result in the evolution of a paradigm shift for the investment industry towards more sustainable investing.
So, what exactly is it? Under sustainable investment, a key principle is that the fund manager responsible for investing your money will base his or her decisions not just on what they think will make the most money, but will also consider the broader context of ESG.
For example, when looking at investing in stocks and shares, they will consider how the company interacts with the environment, with staff and local communities and whether they have diversity at a board level.
In simple terms, ESG investing is about taking into account the broader implications an investment may have on our climate, so expect more investment in wind farms and less in coal companies.
Clarity
Further clarity on what investing sustainably means is crucial. One of the drawbacks until now has been the lack of a common position among ESG fund providers as to what constitutes sustainable and what does not. The EU is pressing investment managers to be more clear about what they are doing in the sustainable space and the impact it has on the way they invest.
The EU’s new legislation will outline two broad categories of funds in this respect:
– One, under article eight, for light green funds where the manager markets the fund as having ESG features and must explain what those are and how investors can assess if the features are being achieved;
– Another, under article nine, which covers dark green funds where the product is targeting a specific sustainable outcome, such as climate change, in which case the manager will need to be clear on how the investment will help address this particular issue and how they avoid the bad stuff that has a negative impact on climate change.
We are all more aware now of the negative impact of climate change on our planet
Let’s look at the situation today. Most people have little idea how or where their pension fund is invested. Some may know the provider of their policy, often a large life insurance company, but few of us will have any awareness of what their funds are actually invested in.
So, why should we feel confident that ESG investing is about to become more prominent?
We are all more aware now of the negative impact of climate change on our planet and that we all need to play our part in protecting it for ourselves and for future generations.
It is evident in the little things around us, such as the exponential growth in people arriving into the coffee shop with their own cup to cut down on disposable waste. It makes sense that the same level of responsibility would apply to pension investment if people stopped to think about what they were investing in.
According to research undertaken by Aviva Life & Pensions Ireland last year, 80 per cent of respondents said they would choose an ESG investment over a non-ESG alternative when a clear explanation of the difference was provided. But how many of us are being offered the clear explanation? That has been the issue until now.
The introduction of legislation in this market will be a catalyst for financial advisers to have this conversation with their clients. These moves should be seen as the first ripples in what seems certain to be a coming wave of legislation. As ESG investing matures, regulation will strengthen and the selection of funds available will expand. All this explains why the growing momentum behind sustainable investing should not be met with resistance.
Increase returns
In its early days, another basis for caution was fear about performance. But from an investor’s perspective, sustainable investing may help increase returns.
Morningstar, a leading data provider on global investment funds, issued a report in August. It found ESG funds, which have been around for 10 years, have, on average, outperformed traditional funds.
If your investment manager can engage with and influence companies on your behalf, they can help drive meaningful change at a corporate level more quickly
This shouldn’t come as a huge shock. Companies that have a plan in place to help tackle climate change, treat their staff well and understand the importance of having diversity of thought at management level are likely to perform best over the long term.
More importantly, if we take a step back and consider the big picture – what this shift means for tackling the enormous challenge of climate change – the case becomes even more compelling. If the investment manager of your pension/investment fund is allocating your savings to companies that act more responsibly, you are helping propel the planet towards a more sustainable future.
If your investment manager can engage with and influence companies on your behalf, they can help drive meaningful change at a corporate level more quickly, improving governance and spurring efforts to combat issues such as the climate crisis.
Investors want to see their savings make money. But the returns generated by investment or pension policies are not the only thing most people are interested in. They also want to see a better world for themselves and future generations. The new ESG regulations should bring these goals more closely into alignment. In doing so, they encapsulate a powerful truth – your money can be used to bring about positive change.
