European Wealth Managers’ ESG Opportunity

August 4, 2022
Greg

Greg

Globally recognised expert in applied decision science, behavioural finance, and financial wellbeing, as well as a specialist in both the theory and practice of risk profiling. He started the banking world’s first behavioural finance team as Head of Behavioural-Quant Finance at Barclays, which he built and led for a decade from 2006.

European Wealth Managers’ ESG Opportunity

As ESG investing grows in popularity, it’s increasingly important for wealth managers to understand what precisely it is that’s popular. What do we know about what investors really want? Where are the biggest opportunities? And where are the challenges – including compliance and communication?

What is ESG investing?

  • ESG can be shorthand for aligning investment choices with social-impact goals: a catch-all term for a style of investing that concentrates on companies that, alongside trying to make a profit, are trying to make the world a better place (or at least are not actively making it a worse one).
  • ESG also refers to a means of channelling resources to specific environmental, social, or governance causes: encouraging companies to attract capital by attracting investors who care about these causes.
  • More cynically, ESG can be seen as a branding exercise, where it’s less about actually pursuing positive change, and more about looking like you’re plausibly trying; so-called ‘greenwashing’. For fund managers, this could translate to merely adding ‘sustainable’ to an existing fund’s name. For investors, it could be about the promise of financial returns from jumping on the green bandwagon, regardless of any social outcomes.

Probe further, and it quickly gets more complicated still.

Starting with the name. We’ve asked thousands of investors across the world how familiar they are with terms such as ‘ESG investing’ and related others. For some, ‘ESG investing’, ‘sustainable investing’, and ‘responsible investing’ are interchangeable. Others will insist that they are different. Answers vary slightly across populations, but nowhere is one term or one interpretation especially popular.

Then there’s the question of measurement. What counts as meeting an environmental, social, or governance goal? How are such things measured? Who’s keeping score?

How do you balance a carbon footprint against an equality and diversity metric? Should you even try? How do you account for subsidiary companies in governance issues? And so on.

Are there ranges of ‘goodness’, or does a company qualify as ‘good’ if it meets a certain threshold, and ‘bad’ if it doesn’t?

Amid this confusion of questions, one thing we can be sure of is that assessing sustainability preferences (across multiple dimensions) is a core part of understanding individual investors, and therefore of providing them with suitable advice for them as individuals. Alongside keeping companies accountable, a key purpose of any measurement is to better match investments to investors for whom they’re suitable.

How much demand is there for ESG investing?

The ESG market is big, and it’s getting bigger. Professionally managed assets with ESG mandates are estimated to already exceed $40 trillion, and are predicted to represent between a third and a half of all global assets under management in the next few years.

However, the size of the existing market is less important than what’s being done with it, and where it’s going. Not least because the better the industry understands what, precisely, is being demanded, the bigger that demand is likely to become. ESG should be seen less about shuffling assets around and more about engaging new groups of investors.

What do we know about investors' ESG preferences?

ESG preferences are far from one-size-fits-all. At Oxford Risk, we’ve been tracking responsible-investing preferences for years, and it’s clear that investors interested in ESG are trying to meet many different – and often contradictory – goals. To understand individual investors, you’ve got to do more than ask them how much they care about polar bears or disapprove of gun running on a scale of 1 to 10.

To take the most consequential example: some are not only willing, but positively keen to make financial trade-offs for social good. Others are not. Of the several thousand investors we’ve surveyed worldwide, 59% agreed with the statement: ‘I would accept a lower financial return if an investment had social benefits.’ Only 12% disagreed. If you took your cues from ESG advertising, you’d believe those numbers were the other way around!

Using the UN Sustainable Development Goals as a guide, we’ve consistently seen that investor preferences for specific causes tends to cluster around each element of E, S, and G – meaning it makes little sense to advertise ESG funds as indiscriminate bundles. For example, if you support Climate Action, you’re more likely to prioritise other environmental goals over governance ones. This is speaking broadly, of course. Each investor has a unique recipe of what moves them.

We’ve also looked at preferences for evidence. What proof do people want to see that an investment is keeping its promises? Our research has demonstrated that investors – understandably – seem not to distinguish much between sources of evidence, or between more or less credible evidence.

When asked what information they would find most useful when considering making a sustainable investment – e.g. an independent suitability ranking relative to peers, or against an absolute score, or simply being labelled as ‘sustainable’, and so on, there was remarkable consistency across all options – investors simply don’t differentiate between them much. But they do want to see something.

For most it’s not only about the details or the numbers, it’s about emotional comfort that these things do what they claim to do, and trusting in independent parties to verify those claims.

What do the European ESG regulations say?

Considering suitability preferences is part of the latest set of MiFID II regulations. But what counts as considered?

There are two ways to approach meeting any set of regulations. You can focus on the letter of the law, or the spirit. Focusing on the spirit reliably satisfies the letter. The reverse isn’t always true: ticking every box can still miss the mark.

For example, you could design a process that prompted an investor to state simply: ‘Yes, I’d like some ESG’, and end up with a token-gesture allocation to a fund that changed its name to include ‘sustainable’ a couple of weeks before. That would tick the box, but it would be a stretch to call it suitable. It would meet the letter of the law, but it would insult the spirit of it.

Fortunately, keeping regulators and investors happy needn’t be at odds. To see how, read our guide: ESG: The Compelling & The Compliant.

What is the future of ESG investing in Europe?

Given the complexity of both human preferences, and the ESG world in general, there is a temptation to steer the bandwagon around the hard questions of what investors want.But with the right use technology we don’t have to. A behaviourally conscious analysis of the nuanced world of investor ESG preferences, set within a framework designed to match investors to investments at scale, allows us to see better solutions more clearly, and generate better and more sustainable outcomes as a result.

For more information around meeting MiFID regulation or matching clients with suitable and sustainable investments, please email contact@oxfordrisk.com.

ESG: The Compelling & The Compliant - Download the Guide Now

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