ESG funds – the real deal or pretenders?

There are plenty of fund managers who claim environmental, social and governance (ESG) credentials, but how many of them are actually the real deal?

Lonsec’s new sustainability score tries to cut through the noise by providing investors with a tool for evaluating sustainability across both ESG and traditional funds.

When clients approach advisers looking to specifically invest in ESG, the problem has been distilling the true-to-label ESG players from those which only tick some of the boxes and, as Lonsec’s head of sustainable investment research, Tony Adams, points out the objectives of investors are not necessarily identical to those of the fund managers.

Adams acknowledges that there have always been “pretenders” in the mix when it comes to ESG managers, but a part of the issue is that mum and dad investors view ESG very differently to professional fund managers.

“Well I guess that I can’t disagree that there are pretenders and there are a number of them but importantly there are different approaches to ESG and this is where the gap comes up because there are a lot of institutional fund managers who when they put in ESG are talking about a different thing to what mum and dad investors are talking about,” he said.

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“When they [the institutional investors] are talking about ESG they are thinking about looking at it through an investment prism – i.e. what will the ESG risk do to the value of this company?”

“However when the mum and dads are looking at this they are looking at it through the prism of what are the ESG risks as they pertain to me and what does this mean for my community, my planet and my grandchildren,” Adams said.

“The bottom line is that the perspective the institutional fund managers and the mum and dad investors are coming from is different,” he said.

Research house Lonsec has spent most of the past 12 months developing what represents a new approach to rating funds and is unashamedly marketing it to financial advisers as something which differentiates Lonsec from its competitors.

Under the new regime, all funds covered by Lonsec are issued with a sustainability score, which reflects the underlying investments of individual products and their compatibility with the United Nation’s 17 Sustainable Development Goals (SDGs).

Lonsec said the research was being provided in partnership with Sustainable Platform, a leading provider of sustainability data for investment managers and institutions.

In a further announcement of the new approach issued late last month, Lonsec Research executive director, Lorraine Robinson, said that while the concept of ESG was part of the investment selection process and had been around for a long time, there had been a distinct lack of clarity around what it really meant for the end investor.

“Lonsec wants to bridge this understanding gap by offering research that looks past the process and directly analyses the assets and industries that investors are exposed to when they invest in a managed fund product. This is what investors ultimately care about,” she said.

Robinson said Lonsec believed the new research would enable financial advisers to better meet their clients’ investment needs and expectations, as well as helping fulfil their best interest obligations.

“There is growing awareness among investors of the importance of considering sustainability issues when constructing a portfolio,” she said. “Advisers are now typically confronted with the question: ‘What am I really invested in?’ We want to help advisers not only answer this question, but to create a portfolio that is truly aligned to their client’s preferences.”

Robinson said that under Lonsec’s new approach, a Sustainability Report was issued for each fund that underwent assessment - a two-page document detailing the relative success of the fund in supporting the SDGs, together with any exposure to the 10 controversial industries.

“The Lonsec Sustainability Score reflects the net impact of these measures, which is peer ranked and results in a score of between one and five bees,” she said.

Lonsec rolled the new approach out in May with the company’s executive director of sales and marketing, Robert Hardy saying it had been well received by advisers.

“We’ve had extremely positive feedback and the objective is to educate and inform because there is significant misunderstanding about what ESG means – the biggest piece that’s missing is what is ‘good stuff’ when the ESG process doesn’t guarantee people are not investing in bad stuff,” he said.

Adams said that from an adviser’s point of view, the bottom line was accepting that very often the perspective of the institutional fund managers and the mum and dad investors were coming from were very different.

“There are certainly a lot of traditional fund managers who have very good ESG processes in that institutional process and yes they do look at the environmental, social and governmental elements and they do understand the risks and, if they’re being paid enough to take that risk, they’ll take it,” he said.

“Because they’re thinking about it in terms of the future value of a firm but they’re not necessarily thinking about the risk to the future of the planet.

“So there are certainly companies and funds and fund managers who will come up on our ESG analysis as very strong ESG managers because they do the work, they understand the risks and they engage with the companies but that does not mean that their portfolios will align with what investors are looking for,” Adams said.

“So that is what we’ve tried to do – we’ve tried to separate the two – the way it happens in the ESG and how fund managers think about it in terms of the investing process and then we look at it from the perspective of the investing clients and what they care about.

“And what the investing clients are about is whether a portfolio is full of coal mining companies or what sort of other allocations are in the portfolio,” Adams said. “They’re not really that concerned about the gender gap in the senior executive of the company.

“So this is about looking beyond the marketing stories the managers are trying to tell, their merchandising and their process. Instead, we’re looking at their portfolio and we’re rating their portfolio based not only on what a particular company is, but what it makes (products and services) and how are they used.

“By mapping them, on the good side to sustainable development goals and on the bad side against controversies and by providing a single score. It’s a case of looking through the fund manager story to what they actually own.”

Asked whether he was surprised by the number of ESG funds which had not lived up to their promise in terms of the new Lonsec approach, Adams said he was not surprised.

“I was not surprised, I’ve been in the game for a long time and I know there’s been a lot of marketing stuff that goes on,” he said. “There’s certainly some misbranding of funds that goes on out there.

“There are certainly some funds that are mislabelled and, of course, there is no formal definition of what ‘sustainable’ means but they are using those sorts of labels with some poetic license.

“When we rank our scores, our sustainability score is one through five where one is the best and five is the worst and we utilise a bell curve where if you’ve got a one you’re pretty damned good and when we put our responsible investment sector funds through it almost all of them are fours and fives and one of them was a three.

“And that didn’t surprise me,” he said.

“There are certainly funds that are labelled ‘ESG’ as opposed to being labelled ‘sustainable’ or ‘ethical’ that are not necessarily delivering what an end investor might think about them because the lens they are looking at it through is different,” Adams said.

He said that he believed that by producing a score and condensing the analysis down to two pages, he hoped Lonsec would create some good conversations between investors and financial planners.

“We want it to create the opportunity for advisers to help their clients look at a fund and decide what it is doing and why it is good,” Adams said.

“I hope we’re providing the information in a useful way which allows the planner to engage with their client and then planners can go back to particular fund managers and ask why they’ve got uranium in their portfolio when its supposed to be a sustainable fund,” he said.

“It’s about enabling that discussion between clients and financial planners.”