REBA Inside Track: Talk Money Week and COP27 may have more in common than we think
We’ve just reached the end of Talk Money Week, and in the midst of a cost-of-living crisis, perhaps it’s no surprise that very little of that conversation focused on Environmental, Social and Governance (ESG), or sustainable finance.
In the same week, speakers at the COP27 summit reinforced the scale of the challenge facing all countries and businesses if we are to rein in carbon emissions and limit permanent damage to the planet. But with a prime minister initially loathe to attend, and with pressing domestic issues, those messages risk becoming part of the background noise.
Is the end nigh for ESG? Is it an investment luxury at a time when increasing numbers of people have more pressing priorities to think about, and attractive returns are on offer from controversial sectors?
The ESG cynic has plenty of evidence to argue for a rethink. Energy companies have reported record profits linked to electricity and gas, and the war in Ukraine has boosted the performance of many defence-related businesses. From an investment perspective, these look like attractive returns from two sectors usually seen as being at odds with ESG and responsible investment at a time when stock market volatility has made good returns hard to find. And while it’s sometimes difficult to compare like-with-like, many ESG-labelled funds have struggled to match the performance of more conventional funds so far this year.
ESG fund practices have also come under close scrutiny. The Financial Conduct Authority (FCA) has its sights on new rules to address ‘greenwashing’, when fund managers make exaggerated or unsubstantiated claims about the ESG credentials of their funds. This is important if investors, both individually and in workplace savings such as pension schemes, are to be confident they really are investing sustainably.
However, the FCA’s proposals present part of a bigger challenge for ESG fund managers: how do funds accurately report on their investment principles and practices, measure progress and report on it in a language that pension scheme members can understand?
Like other aspects of investing, there are many different ways that funds implement ESG. Some will completely exclude particular sectors (such as energy and defence). Others might invest in all the companies in an index such as the FTSE 100, but allocate a greater percentage to companies that are climate-aware, and invest less in those that aren’t. There are also more sophisticated funds that will hand-pick companies based on close analysis of corporate behaviours, governance structures and demonstrable progress towards doing business in a climate-aware fashion.
Each of those approaches will have different costs attached to them, different ways of measuring success, different ways of demonstrating value for money – and that can make performance comparisons difficult.
There are some common measures such as the Taskforce on Climate-Related Financial Disclosures (TCFD) framework, which all UK pension schemes must now report against, but these don’t always tell the whole story. TFCD helps to document how climate risks are being managed in an investment strategy, but won’t show whether an asset manager is investing in potentially lucrative positive opportunities such as green energy companies, or aiming to have a positive long-term impact on the society around them.
However, these are all growing pains, not reasons to give up on sustainable and ESG investment principles, either in pensions investment or other forms of saving. The FCA (and The Pensions Regulator’s) expectations from pension schemes and their fund managers show that ESG investment is here to stay. The challenges that fund managers face in monitoring and reporting on sustainable investment are indicators of a maturing industry, not a reason to move away from it. And looking at long-term performance, rather than short-term market trends, is one of the biggest advantages of pension scheme investment.
And while many pension scheme members may be focused on more immediate financial matters, they still want schemes to invest responsibly on their behalf, and explain to them how they are doing so. Talk Money Week and COP27 may seem like worlds apart – but perhaps they have more in common than we think.