For many financial advisors and their clients, ESG disclosures and ratings can be confusing and frustrating.
But advisors can cut through the confusion if they understand what to look for and how to match that to their clients’ expectations, delegates at the Responsible Investment Association conference heard on Wednesday.
Bryana Lee, senior legal counsel, investment management with the Ontario Securities Commission (OSC), said there are a few things advisors should look for in fund disclosures to determine whether a fund meets their clients’ requirements.
“It’s sometimes tempting to see the name of the fund and think you understand what that fund is focused on, but I think it’s important to delve deeper into the disclosure,” she said.
One thing Lee said advisors should look for is whether a fund is broadly focused on environmental, social and governance issues and whether those three pillars are equally weighted, or if the fund is more focused on one pillar than the others or a subset of those three pillars. They should then measure that against what their client values.
Another area advisors can dig into is the extent to which ESG factors were considered by a fund, Lee said.
She noted that ESG may be the primary focus of some investment funds, while some other funds consider ESG as one of many factors.
Lee also highlighted the importance of evaluating negative screens.
Some ESG funds will have negative screens, she said, “but that does not necessarily mean that they always really have 0% of holding in that industry.” It’s essential for advisors to look at the fine print.
“Some prospectuses say, ‘We might have a de minimis holding, like 0.5% or something in our portfolio’ in this industry that you might think that they screen out,” Lee explained.
“And then there would be other funds that truly do screen out — 0% of the fund is held in this industry, but they don’t screen out an industry that maybe feeds into that industry. … Different investors will have different feelings about whether that’s appropriate for them.”
Rating agencies’ role
Clark Barr, head of methodology with Morningstar Sustainalytics, acknowledged that sifting through fund documents for these details can add quite a bit of work to advisors’ jobs. Part of the role of rating agencies in the industry is “doing some of that legwork for advisors,” he said.
With Morningstar Sustainalytics ratings in particular, Barr suggested reading the agency’s methodology for different ratings to understand how in depth they are as well as limitations they may have. He noted that there are some ratings that cover negative screens, for example, so advisors won’t have to dig much deeper into that area.
“It might not meet your clients’ needs exactly, but it might even give you a starting point to meet those clients’ preferences,” Barr said.
Matthew Kan, senior advisor, behavioural insights with the OSC, said investors need to “have their eyes open when they’re actually going in and investing in ESG.”
One factor investors need to consider is that some ratings reflect how ESG risk is being managed as opposed to ESG impact itself, he said.
Kan, who co-authored an OSC report about ESG ratings last fall, also noted that while there’s “good information” out there that ESG ratings are based on, this information may be incomplete or could be updated.
Another challenge with ESG ratings, he said, is that it’s difficult to compare these ratings across industries.
Varied approaches
Laure Maillard, senior advisor with Desjardins who oversees retail responsible investment disclosure at the firm, named a few other challenges that advisors specifically face in the responsible investment landscape.
She said it can be time consuming to do due diligence and difficult to manage differing client expectations about the same products “in a more polarized world today.” There’s also an abundance of products to choose from and there’s still no unified approach to responsible investing, adding to the complexity of the space.
“Responsible investment is, in fact, an umbrella term that means a lot of different approaches, [from] the more simple vanilla ones to sophisticated ones,” Maillard said.
Kan said this complexity, along with greenwashing concerns, tends to cause investors to disengage from ESG investing and lose trust in it.
However, he stressed that advisors should not shy away from learning more about responsible investing because the more knowledge they have, the better they can support their clients and earn their trust.
“Because investors don’t really know as much, they certainly do take advisors’ words on any recommendations at face value. They’re not going to come back and second guess you,” Kan said.
“So, I think it’s very important [for advisors] to understand that information and be able to translate that to your clients, because by building the trust and having positive engagements, that leads to reinforcement and leads to future ESG investing as well.”