How to proactively integrate RI into your practice

Everything you need to know to successfully incorporate RI into your practice

March 2021

Nalini Feuilloley

Director, Responsible Investment Team

LEARN MORE ABOUT THE AUTHOR

20 MINS UNSTRUCTURED CPD

Subscribe to our Insights

Risk Disclaimer

The information, opinions, estimates or forecasts contained in this article were obtained from sources reasonably believed to be reliable and are subject to change at any time. It has been produced for information only.

Views and opinions are those of the author and do not necessarily reflect those of BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned. No action must be taken or refrained from being taken based on this content alone.

Key takeaways:

  • Understand the market background to Responsible Investment
  • Explain the different investment approaches within Responsible Investment
How to proactively integrate RI into your practice

There is no disputing that the world of Responsible Investing (RI) is burgeoning and more investors want to drive positive, meaningful change through their portfolios.

Director of the Responsible Investment Team at BMO Global Asset Management, Nalini Feuilloley, tells advisers everything they need to know to practically – and successfully – incorporate RI into their practice, including how to avoid greenwashing and important issues to have on your radar now.

Get ahead of the curve on future regulation

It’s no secret that the RI movement has grown exponentially in a short amount of time. Increasingly more mainstream investors have come to accept that RI is no longer a “niche-style” of investing – or a stylistic trend – but rather, a fundamental best practice.

Several factors have contributed to this evolution, including the $30 trillion intergenerational wealth transfer taking place currently1: ageing investors are thinking about the next generation, while millennials – a large and important demographic for advisers – are making more thoughtful decisions on how they want to contribute to their investment portfolios, as they look to solve the world’s sustainability challenges through the allocation of capital. According to a 2019 Morgan Stanley Institute survey of high-net-worth investors, 95% of millennials are interested in sustainable investing.2

Increasingly more mainstream investors have come to accept that RI is no longer a “niche-style” of investing – or a stylistic trend – but rather, a fundamental best practice.

In the institutional market, growth has also progressed enormously on the RI front, spurred by significant regulatory developments. Numerous environmental, social and governance (ESG) integration policies have been legislated, for example the imbedding of ESG preferences into Statement of Investment Principles of large UK occupational pension schemes in 2018. And further top-down intervention can be expected, especially as regulators and central banks take heed of the potential financial implications of climate change and encourage greater transparency from investors on how these are being managed.

Case in point: the UK Government’s Green Finance Strategy or The Ten Point Plan for a Green Industrial revolution, laying the foundations of the UK Government meeting the commitment to a Net Zero target by 2050.

Simply put, sooner rather than later, there will no longer be a choice as to whether we should be responsible investors – or advisers. It’s a reality we ALL need to embrace within the investment management industry.

Retail demand: Percent who feel sustainable investing is more important now than five years ago
  • Millennials: 86%*
  • Generation X: 79%
  • Baby boomers: 67%

 

$3.9 trillion of assets are likely to be transferred to future generations over 10 years.

*Millennials are born between 1983-2000, GenX 1978-1982, Baby boomers 1949-1967

Sources: PRI 2018 Reporting Framework responses; “Global perspectives on sustainable investing – Global Investment study” Schroders, 2017; Wealth X and NFP Wealth Transfer Report, 2016.

Expanding your understanding of responsible investing

Nevertheless, there’s still a misconception among advisers (and their clients) that RI limits their universe and equates to exclusionary, ethical investing – and therefore divestment. Yet that this is only one of the five defined approaches from the Investment Association.

Five Investment Association RI definitions:
ESG Integration The systematic and explicit inclusion of material environmental, social and governance (ESG) factors into investment analysis and investment decisions
Exclusions Prohibitions of certain investments from a firm, fund or portfolio
Sustainability focus Approaches that select investments on the basis of their fulfilling certain sustainability criteria and/or delivering on specific and measurable sustainability outcome
Impact Investing Investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return
Stewardship The responsible allocation, management and oversight of capital to create long-term value leading to sustainable benefits for the economy, the environment and society

While it’s certainly valid to say “I don’t want to focus on impact funds that address one issue in the RI sphere, such as climate change,” it would be detrimental for your business to disregard how ESG factors play a role in the management of client portfolios – especially for those invested over the longer-term. For example, Facebook showed many warning signs (from an ESG lens) prior to the massive data breach it experienced in 2018 that led to the biggest one-day drop in market value of any company in history. In retrospect, many could have avoided Facebook’s negative impact on their portfolio performance if they had incorporated governance factors into their decision-making processes.

Perhaps the biggest hurdle facing advisers is the fear that RI approaches could conflict with fiduciary duty, or that these strategies can detract from performance. In fact, numerous studies have found evidence to support that taking ESG into account can help protect against volatility and downside risk.3

Research from data provider Morningstar examining the long-term performance of a sample of 745 Europe-based sustainable funds shows that the majority of strategies have done better than non-ESG funds over one, three, five and 10 years.4 That’s why it’s vital for advisers to take the time to understand what RI is – and what it’s not.

We already know that investors are interested in RI. The 2018 HM #InvestInAbetterWorld survey indicated that 2 out of 3 respondents thought that financial institutions should avoid investing in companies that harm people or the planet. 5

The client conversation: becoming the subject matter expert

So how do you incorporate RI into the client conversation?

As a first step, education is paramount in order to be effective. While you don’t need to be a specialist on every aspect of RI, you should be able to tell the story, including what it represents today, and what it means in terms of strategies and the various approaches. Whether that means taking a course, or speaking to an expert, it’s incumbent on advisers to grow your knowledge base as part of your professional development.

To start you down the path, click here for an RI Investment Spectrum to help you decode the intricate world of RI and assist you with your client conversations.

Whether it means taking a course, or speaking to an expert, it’s incumbent on the adviser to grow your knowledge base as part of your professional development.

I would then encourage advisers to proactively broach the conversation and let clients know the different ways RI can manifest in their portfolios should they be interested. For example, you can state that you will undergo due diligence into investment managers on their behalf to assess how ESG factors are integrated. Taking it one step further, pose the question: “do you have any specific values or beliefs you would like to see incorporated into the management of your portfolio?” If clients are passionate about certain causes (e.g. gender diversity, or climate change), then take them through their available options – from exclusion to sustainable, or impact investing.

Importantly, it’s about ensuring that clients aren’t stuck in the mindset that RI only represents ethical investing, or divestment and widening their perspective to the many accessible – and robust – strategies.

Accountability: delving under the hood

In terms of integrating RI into client portfolios, holding investment managers accountable is key, and the biggest component of this is delving under the hood, because “greenwashing” – a form of marketing spin that uses green values to deceptively persuade – is real and rampant as RI demand grows. The ESG integration approach is particularly relevant here since it has yet to be defined in exactly how it’s accomplished, and it transcends “RI/ESG” branded products. As a result, how ESG factors are taken into consideration is unique and proprietary to every manager; there is no standard benchmark. But that doesn’t mean it can’t be a valid and robust approach if there’s a material impact on buy, sell and hold decisions. For advisers, that means asking pertinent questions like “what data sources are you using to screen for ESG?”; “do you have your own proprietary scoring method?”; “how does your approach affect your buy, sell and hold decisions?”

Holding investment managers accountable is key, and the biggest component of this is delving under the hood.

Some managers can answer basic questions readily because they have a stock response ripe and ready. If, however, you dig a little deeper, you’ll undoubtedly be able to discern the leaders from the laggards. Advisers should also question how managers use engagement and proxy votes to encourage ESG best practice with companies, which will help you inform your clients – and engender trust in the process.

Moving forward with climate change

Looking ahead over the medium term, there’s no doubt that climate change will take the focus of the ESG landscape. As such, advisers should educate themselves on the issue and try to assess how much climate risk has been priced into their clients’ portfolios. In the run up to the critical COP26 climate meeting later this year in Glasgow, we can anticipate further government intervention and while this is somewhat removed from the end client, we expect to see disruption in the financial sector if more top-down climate regulation is introduced. Therefore, prioritising climate change as a central piece in holding investment managers accountable to these environmental factors will help soften the impending blow in the next three to five years.

Crucially, for advisers, it’s a matter of not disregarding the RI movement and taking it for granted, because the alternative is to fall behind – particularly as client demand escalates. Realise that it’s not simply about branded funds, although these will be the right option for some: it’s about scrutinising ALL investment strategies through an RI lens and proving that ESG integration is a demonstrable part of every manager’s skillset and understanding. Ultimately, it’s an opportunity for true partnership – helping your clients fulfil their desire to make a difference, while maintaining healthy returns.

Your essential RI resources

Consumer guide to responsible investing
Consumer glossary of responsible investing terms
The spectrum of responsible investing choices
Responsible advice integration roadmap

Sources
1. Accenture, “The ‘Greater’ Wealth Transfer – Capitalizing on the Intergenerational Shift in Wealth,” 2012.
2. Morgan Stanley Institute for Sustainable Investing, “Sustainable Signals – The Individual Investor Perspective,” 2019.
3. BMO Global Asset Management, “Performance with Principles”, 2017; University of Oxford and Arabesque Partners, “From the Stockholder to the Stakeholder,” 2015; Bank of America Merrill Lynch, “ESG Part II: A Deeper Dive,” 2017; Morgan Stanley Institute for Sustainable Investing, “Sustainable Reality,” 2015
4. “How Does European Sustainable Funds’ Performance Measure Up? – Morningstar Manager Research, June 2020
5. HM Government, #InvestInABetterWorld 2018

Risk Disclaimer

The information, opinions, estimates or forecasts contained in this article were obtained from sources reasonably believed to be reliable and are subject to change at any time. It has been produced for information only.

Views and opinions are those of the author and do not necessarily reflect those of BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned. No action must be taken or refrained from being taken based on this content alone.