The Quiet Revolution

Increasing demand from investors to use their money as a force for good has driven a huge rise in the number of funds promoting their ‘ESG’ (environmental, social and governance) credentials. Unfortunately, it has also given rise to funds labelling themselves as green, ESG or sustainable when this isn’t necessarily the case.

Whether deliberate or not, so-called greenwashing can lead to clients’ money being invested in a way that goes against their wishes and beliefs. It can be difficult to identify, but with new sustainability- related rules for advisers on the cards, greenwashing is an issue that can’t be ignored.

What is greenwashing?

Greenwashing is the term used for labelling a product or service as sustainable or ethical, when in reality this is not true. While the term did not originate in financial services, it has come to be used to describe the over-exaggeration of an investment’s ‘green’ credentials, the impact it can have, or implying screening based on ESG factors has occurred when it has not. Greenwashing can also be unintentional – a result of poor knowledge of sustainability, rather than deliberate attempts to deceive.

Accusations of greenwashing have increased in tandem with the amount of money flowing into the ESG investment space. InfluenceMap, a London- based climate change think tank, published a report last year which accused 71% of the 593 equity funds marketed as ESG as having a negative ‘Portfolio Paris Alignment’ score. This indicated that their portfolios were “misaligned from global climate targets”, the report said1.

Regulatory agenda

Greenwashing could become an increasingly important issue for advisers if the Financial Conduct Authority (FCA) proceeds with its suggestion to introduce specific sustainability rules in the advice process. In a discussion paper published in November 2021, the FCA said it would be “appropriate to confirm that advisers should consider sustainability matters in their investment advice and ensure their advice is suitable and reflects consumer sustainability-related needs and preferences2”.

To meet such a requirement, advisers will need to be certain that the investment products they are recommending to clients do what they say on the tin. For many traditional funds, this tends to be straightforward – it’s fairly easy to spot if, say, a ‘global equity’ fund is not in fact investing on a global basis.

For sustainable funds, however, working out what they really do is difficult even without the potential for greenwashing. While attempts have been made over the past few years to introduce consistency into the industry, terms and definitions like ESG, impact, responsible, ethical and sustainable are still used interchangeably and mean different things to different people. Add in the risk of greenwashing, and the need to do a deep dive into funds’ investment processes and underlying holdings increases further.

Identifying greenwashing

Identifying and avoiding greenwashing requires thorough research – not only into the investment itself, but also into each of its underlying holdings. Few advisers have the time or resource to conduct this process themselves, but there is help at hand in the form of technology.

There are a range of tools being developed which enable advisers to filter and/or rate funds and their underlying assets in line with clients’ sustainability preferences. These can include issues such as renewable energy and alcohol exposure, through to women in leadership and human rights. Some tools will assign an ESG rating to their client’s entire portfolio. The tools aim to help advisers demonstrate their performance against the client’s ESG preferences, while also fostering a more in- depth conversation with clients.

Digging deeper

There is, however, a danger of overreliance on ESG scores when making investment decisions. It would be easy to set an arbitrary cut-off point and say that any company above or below a certain score is sustainable or ethical. Yet each ratings provider has a unique methodology, which prioritises different factors and so vital pieces of information may not be reflected in those scores.

For ESG scores to be truly valuable, it’s important to understand the methodology behind them and, ideally, use them as part of a more in- depth analysis process which considers all the elements that contribute to the sustainability of an investment. Given the complexity involved, one option worth considering is to partner with a discretionary fund manager (DFM) who has the capacity and expertise to conduct thorough research that extends beyond the numbers.

"Identifying and avoiding greenwashing requires thorough research – not only into the investment itself, but also into each of its underlying holdings. Few advisers have the time or resource to conduct this process themselves, but there is help at hand in the form of technology."

At Brewin Dolphin, ESG integration is a central part of the responsible investment approach that we deploy for all investors. Our in-house analysts build a deep understanding of companies, including the risks to each business now and in the future, how they manage controversies, and how robust their policies are. This enables us to assess ESG risks, estimate growth, and evaluate the long- term sustainability of the company. We actively engage with funds so that we can dig deep into how they consider ESG factors for specific companies and sectors and, if necessary, challenge them on controversial holdings. We can also use an ethical screening approach to exclude companies operating in specific sectors.

Considering ESG factors is a central part of our approach to Sustainable MPS, which avoids investment in specific harmful sectors, and invests in companies and funds that seek a positive societal or environmental impact. Each risk-rated portfolio has been independently reviewed by Defaqto and independently rated by MSCI according to the ESG characteristics of the underlying holdings and their carbon intensity.

In a further sign of our commitment to investing money in a way that delivers long-term, sustainable returns, we are proud to have been included in the first list of signatories to the Financial Reporting Council’s UK Stewardship Code 2020. The new version of the code has an increased focus on activities and outcomes, rather than on policies, and references sustainability, the environment and society.

With sustainability-related demands on advisers set to increase further, handing over responsibility for ESG research to a DFM provides a robust way of meeting clients’ needs and beliefs in the ever- changing investment and regulatory landscape.

For more information, please visit www.brewin.co.uk/intermediaries/our-services/risk-rated-fund, email SalesSupport@brewin.co.uk or call us on 0203 201 3520.