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For professional clients only, not suitable for retail clients. This is a financial promotion and is not investment advice. The views expressed are those of the contributors at the date of publication unless otherwise indicated, which are subject to change, and are not investment advice. Issued in June 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.
However, the relationship between advisers and their clients is one of the many areas where this transition is still a work in progress. Consumers that care deeply about the carbon impact of their choices don’t necessarily make the connection with their pension arrangements. And their advisers are not always educating them on the value of responsible investment, both in terms of the contribution they could be making to the environmental cause but also what the financial returns could look like.
“More can be done to seize this important opportunity”
he growth of responsible and sustainable investing is changing the shape of the investment industry and could prove critical in
supporting the transition to a lower carbon and more socially just world.
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RESPONSIBLE INVESTING
For Professional Clients only
IN PARTNERSHIP WITH
Joining the dots
But does it need to watch its step?
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THE WIDER MARKET:
Responsible investment now has real traction
THE ROLE OF ADVISERS:
Advisers are the gatekeepers to the solutions
CUSTOMER views:
Clients are keen when they understand the potential
he responsible investment market has taken flight over the past two years. The pandemic has prompted a wholesale reassessment among policymakers, institutions and
consumers of their relationship with the planet, and many investors have recognised the direction of travel, with flows into responsible investment funds soaring in 2020 and 2021.
In this Spotlight guide, Royal London’s Sarah Pennells, Ryan Medlock and Jamie Jenkins look at what their recent research reveals about attitudes among consumers and advisers, as well as the future for responsible investment. It is an exciting moment for a fast-moving industry, but more can be done to seize this important opportunity.
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For Professional Clients only, not for Retail Clients
The role of advisers in educating clients about responsible investment
SPOTLIGHT
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'Customers are keen when they understand the potential'
Many clients are enthusiastic about responsible investment when they are told what it can offer. They just need help to build understanding, says Sarah Pennells
(1) United Nations, Report of the World Commission on Environment and Development, Our Common Future, 1987
Source.
My starting point is that not everything that matters can be measured
who has lived with a teenager knows that fast maturation comes with challenges and a few wrong turns.
he world needs responsible and sustainable investing to mature and grow so that it can drive beneficial change more quickly. But anyone
For Mike Fox, Head of Sustainable Investments, the overarching positive change in the last few years is that “responsible and sustainable investing has an influence and cultural acceptance it simply never used to have.”
According to Fox, who runs RLAM’s sustainable fund range, “the corporate world now understands the potential financial benefits as well as the social benefits of responsible and sustainable investing – a big shift because if a company believes it might get higher valued equity and cheaper debt from improved sustainability practices then its philosophy is going to move pretty rapidly.”
Ashley Hamilton Claxton, Head of Responsible Investment, has recently been attending broker-arranged conference calls for issuers and says many firms are asking themselves how they can attract the new Environmental, Social and Governance (ESG) oriented investors. “Even the ‘dirty’ companies are realising that this is now affecting capital flows and are reaching out,” she says, though her advice to them is straightforward (see box).
Researching reality
Hamilton Claxton says that a parallel trend is also now clear. “The conversation is moving on from ‘what is the financial ESG risk of my companies or my funds’ to ‘what is their direct impact on sustainability’, in addition to any financial risk implications,” she says. This shift is changing the approach of the Responsible Investment team – who work not just with Fox’s sustainable funds but across RLAM’s investment universe.
“We're thinking more broadly about how we can research, describe and measure the direct impact of large corporations on the world,” she says, “and we’re looking at new information in new ways.”
Fox thinks there is a danger that numbers will take priority over more subtle word-based judgements. “Words are inconvenient because they're unstructured – you can't spreadsheet them and they can mean different things,” he says. “If you're trying to come up with a low-cost, scalable solution, words are a nightmare – you just want a set of data to crunch and create a sustainable portfolio around.”
“But we're buying companies that exist in the real world,” he says, “and to think that you can entirely numericise those companies during the sustainability analysis and attribute no value to the words that provide context to the sustainability numbers is, I think, profoundly wrong.”
(1) Responsible Investment: A passing fad or a permanent future?, from Royal London
“Advisers are in the perfect position to help clients recognise that where they invest today will help shape the world of tomorrow”
“The language of financial services can be off-putting, and terminology around responsible investing adds another layer of complexity”
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Only after that do we start the financial analysis, which is fairly traditional in terms of how we think about investing except that we also take the output from our sustainability analysis and use that to stretch our thinking. For example, the sustainability analysis may suggest a financial risk or, more positively, that there's going to be greater demand over a longer timeframe for certain products than the wider market realises.”
Then we explore the wider E&S issues. For example, in the case of an automotive component supplier, they have big manufacturing footprints and large, often relatively lowly paid workforces – and many have outsourced manufacturing to lower-cost economies. So, there are many potential labour issues.
The final test for us might be to look at the products and services in more depth – documenting whether these will indeed reduce road deaths and decrease emissions. Can we evidence that? That in totality gives us a view as to whether the business is a sustainable business as we would define it.
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Once we make that initial intuitive judgement, we have to analyse the company. We always start with a very thorough corporate governance assessment of the business, asking a number of questions around not just remuneration and board structure but also how they've treated stakeholders – not just shareholders – in the past.
If we can get past the corporate governance test, we start on the environmental and social factors. For every company, we conduct an environmental assessment using, for example, much better carbon data than we used to be able to obtain.
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67%
People who believe we are currently facing a state of emergency due to global warming
71%
People who think everyone is responsible for taking action to address the climate crisis
22%
People who feel that the crisis is being addressed
7%
People who feel the way their pension and investments are invested would make a difference
Customer views on the climate crisis (1)
What explains this apparent gap? For Sarah Pennells, Consumer Finance Specialist at Royal London, most people do not make the connection between their pension pot and the climate crisis. This matters, because new research from Royal London shows that once people recognise that their long-term savings can make a difference, the proportion of those who say they would prefer their pension to be invested responsibly jumps from 7% to 57%.
relatively few clients ask how they can invest more responsibly.
t is clear that people care about climate change. From reducing energy consumption and recycling to protesting outside Parliament, there is no shortage of will, ambition and action to reduce carbon emissions. Yet advisers still report that
I
The publicity around COP26 raised the profile of environmental, social and governance issues, but also the role of finance and – specifically – pensions in helping to build a better planet. “There is a real opportunity both for advisers and for providers,” she says. “People may be thinking slightly differently now.”
Advisers need to step in to help them join the dots, she says. “For most people, a pension is something they pay into but not something they have an everyday relationship with, as they do with, say, going to the shops. Pensions aren’t very visible, so it's perhaps not surprising that customers don't always make the link between their pension and what it might be able to do on climate change.”
Advisers are in a prime position to develop their clients’ understanding and help them see how their capital can make a difference. “They know their clients, can explain the key issues to them and answer questions,” says Pennells. “They can help them understand the impact of the decisions they're making today on the kind of world that they'll be living in tomorrow.”
Advisers have a vital role not just in helping their clients to navigate the often complex and jargon-heavy world of responsible investment, but also in helping shape their preferences. It may not be that clients aren’t interested, but that they haven’t been asked the right questions.
She adds: “It's about advisers really understanding what their clients want from their money, not just purely in financial terms but in terms of what they want their money to do – for their own standard of living, maybe for their family and for any legacy they leave.”
Given how differently clients feel about responsible investing once they understand what it involves, it is up to financial services providers, including advisers, to bring the concept to life, providing examples and showing where responsible investing has made a difference, including where engagement has prompted companies to change their practices.
“Advisers can add so much value because clients can ask them the kind of questions they may not be able to get answers to elsewhere,” she says.
That said, there are still problems around language. Pennells points out that the language of financial services can be off-putting, and terminology around responsible investing adds another layer of complexity.
She believes there are particular difficulties in explaining engagement. Why is a responsible investment fund holding a fossil fuel provider, for example? It is important that clients understand why it might be better to hold a high carbon company and engage to help it change its practices than to sell out. Advisers have a crucial role in building this understanding among consumers.
It is often thought that there is a trade-off between financial performance and sustainability. This has been widely debunked, with studies showing that incorporating environmental, social and governance criteria can deliver financial benefits; both in corporate performance and in the performance of investment portfolios.
This was also uncovered by Royal London’s research with EY in 2020, which incorporated 2,000 different pieces of research in order to assess whether ESG affects performance. It explores the rise in responsible investing and what investors can expect from it.
However, it is noteworthy, says Pennells, that some investors don’t even mind if there is a financial trade off: “A high percentage of those who would consider a net zero pension – 47% – actively said they would consider it even if the charges were higher and the investment performance was projected to be lower.”
Clients may not be asking questions about these sorts of things today, but that might be because they haven’t made the connection between their long-term savings and protecting the planet. Advisers are in the perfect position to help clients build understanding and recognise that where they invest today will help shape the world of tomorrow.
Performance
The relationship advantage
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'Advisers are the gatekeepers to the solutions out there'
(1) RLAM as at June 2021
At RLAM, we have embraced responsible investing for many years and continue to expand our offering in line with the evolving world of ESG best practice. In 2020, we expanded our ESG integration practices and now integrate these across all our asset classes.
responsible investment and good governance across all asset classes. Alongside this, we also believe that considering environmental, social and governance (ESG) issues in the investment process can help us deliver better returns for our customers and clients.
LAM is committed to being a responsible investor. This means being a good steward of our clients’ assets and promoting
R
Those who don’t talk to their clients about responsible investment may be missing a commercial opportunity, according to Ryan Medlock
“COP26 focused the world’s attention on climate change, and the subject is never likely to be far from the headlines now ”
“Some firms will want to include additional questions within their existing and standard fact find”
“We’ve been hearing about what policymakers are thinking about, but there's not been any real clarity, which makes it hard for advisers to plan”
47%
Want material to support client conversations
The vast majority (87%) want more support to help meet future client demand
35%
34%
Want help researching and selecting suitable solutions
Want support to review ongoing suitability
The support advisers want to see (1)
People are becoming increasingly aware of the trend for responsible investing… demand will quickly follow
ESG topics are here to stay
It is a load of nonsense – just another fad that will soon pass
ESG is a trendy term hyped by the media
Some do, however. Royal London’s Responsible Investment research shows that there are three groups of adviser: a reasonably large segment who expect to see a rise in client demand; a second segment who are hedging their bets; and a third, fairly small segment, who believe demand for responsible investment will be short-lived.
This does mean that a majority are on board with the concept. Yet despite this, only half of advisers reported asking about responsible investment during their client fact-find and only a third raised the subject at client review meetings.
Those advisers that don’t speak to their clients about this topic may be missing a commercial opportunity, says Ryan Medlock, Senior Investment Development Manager at Royal London. “Customers’ attitudes are changing,” he says, highlighting that many would prefer their pension to be invested responsibly, if only they knew about the effect it could have.
Medlock argues that advisers have a role in helping their clients to connect the dots, understanding that their investments have power and can contribute to carbon emissions every bit as much as turning down the heating. While many clients may not ask about responsible investing, it doesn’t mean they aren’t interested.
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And if that isn’t sufficient encouragement for advisers to start broaching the subject, then there is stick as well as carrot. The Treasury recently published its Greening Finance roadmap, which confirmed its discussions with the FCA on implementing requirements for advisers as part of new sustainability disclosure regulations. This has been followed up by an FCA discussion paper that explores how sustainability matters are taken into account within investment advice and how advisers incorporate investors' sustainability preferences to ensure the suitability of advice.
“The direction of travel is towards responsible investment becoming a core and mandated part of financial planning going forward,” says Medlock.
he finance industry has a vast role to play in encouraging the right behaviour from companies. Advisers shouldn’t underestimate their part in this and the value of educating clients about responsible investment.
All advice firms will be at different stages of the responsible investment journey, says Medlock. For those looking to take the first steps, he believes a good place to start is to discuss the issue internally and formulate a business-wide plan, aligning responsible investment with the firm's core values and beliefs.
He also suggests engaging with clients on some of these themes before embarking on a formal fact-finding process, giving advisers a chance to flesh out some of their motivations and interests at an earlier stage.
Medlock emphasises the importance of capturing clients' responses and preferences around responsible investment as part of standard processes. There is no right or wrong way to do this though. “Some firms will want to include additional questions within their existing and standard fact find; some firms may want an additional questionnaire,” he says. “Feeding those responses and preferences into prod target-market analysis work may be useful too.”
How to do it?
In advisers’ defence, there are a number of elements that make it difficult to start a conversation on responsible investment. “Perhaps clients have never had a discussion about responsible investment, climate change, social issues, corporate governance or whether they've got preferences for electric cars,” Medlock says. “To bring something new into the conversation can be a challenge in itself.”
Terminology is also a real barrier – there is a lot of jargon. And added to this is a lack of leadership. “We’ve been hearing about what the European Union is doing, what the Government or the Treasury are thinking about, but there's not been any real clarity, which makes it hard for the majority of advisers to plan.”
That said, there has been some progress. The Investment Association published its industry-wide responsible investment framework in 2019, while the spectrum of capital, which defines different responsible investment approaches and is widely used. The EU is relatively further advanced as it has created definitions under the Sustainable Finance Disclosure Regulation (SFDR).
More is coming, says Medlock. “We know that the Treasury is working with the FCA in developing a labelling regime, and the FCA has proposed specific labels in their DP21/4 paper. Once that labelling regime is confirmed in the UK, it will significantly help advisers and their clients. It will also help asset managers and asset owners in terms of the labelling and disclosure of their own products.” A new green taxonomy for the UK is in development as well. This is likely to have much in common with the EU’s taxonomy, which was launched earlier this year.
The headwinds
Medlock says the industry can do more to support and educate advisers in the interim. This should include, he says, “support material around current definitions and labelling, clearly explaining what these mean, the different responsible investment approaches and how different solutions map to these different approaches, as well as providing information and sample questions that advisers can use with their clients.” These could include pre-engagement questions for advisers who are struggling to start a conversation.
COP26 focused the world’s attention on climate change, and the subject is never likely to be far from the headlines now. That may make it easier to start a conversation with clients. Equally, the pandemic has sharpened the focus on social and governance issues, such as inequality, labour rights and supply chain management.
But ultimately, the onus is on advisers to make it happen. “Advisers have a really significant role to play in the adoption of responsible investment,” concludes Medlock. “Advisers are gatekeepers to the different solutions out there in the market. The more we can make it easier for them to embed responsible investment in their processes, the more we will all benefit.”
Supporting advisers
'Responsible investment now has real traction'
The scale of capital inflows into responsible products, along with the prospect of regulatory mandates, suggest that responsible investment is here to stay, says Jamie Jenkins
The technology in society theme offers all sorts of tricky issues that Mike Fox, our Head of Sustainable Investments, and I talk about a lot. At what point are technology companies part of the problem and not part of the solution? How might AI algorithms affect people's ability to get insurance or their human rights? Our approach to this theme is not wholly developed but it is something we are committed to tackling.
We've come up with a climate score which I think is innovative. We've decided to split climate out from environment, for two reasons. First, it recognises that climate affects every company; and second, it recognises that in ESG scores, the climate metrics and variables tend to drown out other important environmental issues like water usage and a company’s impact on biodiversity.
We’re interested in financial services partly because it's still societally a very unfair industry. Social, gender and other factors mean people end up with very diverse experiences. We think there are interesting business models out there, not often
owned by sustainable funds, that are making credit a lot fairer. That’s in line with our goal of developing investment insights that support our sustainability credentials, while allowing us to move into less crowded spaces.
Financial services
Decarbonising construction and buildings is as important in many respects as decarbonising energy, because of the embedded carbon in buildings and how they're operated. We are
finding ways of gaining access to that by owning construction companies that provide products and services that result in less carbon intensity in the development process.
Construction
Sources.
(2) Press release: record £7.1bn flows into responsible investment funds in 2020 so far, from the Investment Association
(3) Responsible Investment: A passing fad or a permanent future?, from Royal London
(1) SFDR Article 8 and Article 9 Funds: Q3 2021 in Review, from Morningstar.
“ Ensuring a ‘just transition’ is extremely important. We need to bring society with us”
54%
Would like to see more transparent and standard adoption of ESG ratings
53%
Want to see clearer and more transparent information from providers and asset managers
Adviser views on clarity and transparency (3)
European Capital inflows into responsible investment (1)
57%
Proportion of fund flows going into ESG and sustainability funds
50%
Proportion of new funds launched as ESG and sustainability funds
37%
Proportion of total fund assets invested in ESG and sustainability funds
Regulation is only likely to accelerate that growth. Jamie Jenkins, Director of Policy and External Affairs at Royal London, says that while the UK, US and Europe are at different stages, they are moving in the same direction. The priority from here is likely to be to create clear parameters around sustainability, to tackle greenwashing and to ensure proper measurement, so that progress is tangible.
Europe has taken an early lead, through the Sustainable Finance Disclosure Requirement and the Taxonomy Regulation. Its example has shown that as regulation grows more disciplined and coherent, the signs are that fund flows will grow.
The UK is also on the journey, although it still has work to do. Jenkins says that while moves to improve disclosure (through the Task Force on Climate-Related Financial Disclosures) and standardisation (though a new UK taxonomy) are welcome, “what’s missing is an absolute duty to invest responsibly”. He points to the FCA’s most recent consultation on a new Consumer Duty: “There was little mention of responsible investment, leaving it in danger of remaining something of a sidebar issue.”
There is also increasing evidence that given clear choices, investors are plumping for the responsible option. Morningstar data for Europe shows that in the third quarter of 2021, ESG and sustainability funds drew in 57% of all fund flows.(1) This is a rise from 44% in the second quarter.
While these funds currently only represent around a quarter of the overall universe of products, they are 37% of fund assets, equivalent to EUR 3.3trn. More importantly, over 50% of new funds were launched as either ESG or sustainability funds, as fund groups rightly recognise that the universe for non-ESG funds is shrinking. This shows the power of a labelling system in helping to build consumer understanding and drive fund sales.
In the UK, no such labelling system exists, though one is likely to be coming down the regulatory pipe. But even without this support, there is growth. Retail sales of responsible investment funds in the first three quarters of 2020 were up by three and a half times compared to the same period of 2019, and 2021 looks likely to have set further records.(2)
Regulatory pressure
Jenkins points out that responsible investing is intimately connected with retirement outcomes – it seeks to ensure that we improve the environment for everyone, so people don’t live in a house that floods or in a world where their grandchildren’s future is unsustainable. “It is not an act of charity or selflessness. It is fundamentally important to all of us. Increasingly it is also being seen as a critical factor in getting good investment returns over the long term.”
There are other elements that are starting to emerge as the market becomes increasingly sophisticated. The drive to measure impact, for example, is becoming a vital part of asset managers’ offering to investors. It is not enough to want to do good; investors require tangible results. As disclosure improves, this is becoming increasingly possible and desirable.
Equally, while environmental aspects have dominated because the crisis is so immediate and all-encompassing, social and governance elements are moving up policymakers’ priority list and that of investment managers. Jenkins says that ensuring a ‘just transition’ is extremely important. “We need to bring society with us and ensure we don’t leave people behind.” This means ensuring that people working in carbon-heavy industries have jobs to go to as these businesses reconfigure or close.
He also believes that an ‘H’ – health – may be added to ESG analysis by many investment managers. There are increasing targets on healthy life expectancy from policymakers, and employers have a vital role to play in ensuring mental well-being and long-term good health.
The responsible investment market is growing in sophistication all the time. It is broadening and diversifying. Fund managers’ analysis is becoming more granular and spreading into new areas. Greater certainty on the regulatory frameworks, clearer definitions and language, and, even, making responsible investing a duty rather than an option are likely to be key drivers in the next stage of responsible investment’s growth.
Fundamental to our lives
and will continue to grow. Greater regulation is certainly inevitable, with COP26 bringing a raft of new commitments on deforestation, coal and methane emissions.
s we saw in the previous section, there is a significant proportion of advisers who are unsure about whether responsible investment is the real deal. Yet the weight of evidence suggests that responsible investment is here to stay
A
ambition and action to reduce carbon emissions. Yet advisers still report that relatively few clients ask how they can invest more responsibly.
t is clear that people care about climate change. From reducing energy consumption and recycling to protesting outside Parliament, there is no shortage of will,
To read the full research report from Royal London visit adviser.royallondon.com/ResponsibleInvestment
