As a paraplanner, there are a number of aspects you need to think about when it comes to ESG investments. Grant Callaghan, head of paraplanning, Para-Sols, provides some key points to consider when researching.
Know the client
It goes without saying that you cannot research or select an ESG investment without knowing what the client cares about, wants to invest in and what they want to avoid. This is also the difference between investing with ethical preferences and investing with ESG preferences. If a client has ethical preferences, funds with a general ESG pitch are unlikely to be suitable. You will need to consider the specific ethical requirements and screen accordingly (essentially ignoring the ESG aspect in favour of the specified ethical criteria).
If the client does have more generalist ESG preferences, there are some things to consider when researching and selecting investments of this type.
Selecting investments
ESG is made up of Environmental, Social and Governance characteristics. These are fairly independent metrics which typically each provide a score (positive or negative) towards a total score that a fund uses to determine whether to include or exclude an investment.
Companies that score very highly in one area, whichever it might be, can end up having the strength of this one area outweigh the negatives from one or both other areas. A great example of this is in the very recent news of Tesla being dropped from the S&P 500 ESG index; an indicator of how ratings or evaluations in other aspects can outweigh any ratings given to one single area. It’s looking at the companies as a whole that is important.
This can make it tricky when researching funds. Do you focus on the E, the S or the G? Or do you focus on funds that deem the underlying investments to have a high enough score (even if this is lopsided across the E, S or G areas) to be included as enough to represent a suitable ESG option? Again, it comes down to knowing the client.
Aside from the generalist ESG funds, which tend to work on a scoring basis, you can find funds and investments that focus on one particular aim (such as positive impact, sustainability focused, positive or negative selection bias) that may help filter for strategies that align specifically with the individual E, S and G factors.
Looking at the investment method, active or passive, can also help determine how an ESG fund is invested. Active investments are likely to provide more detail and disclosures around how investments are included and excluded compared to passives, which are more likely to rely on the scoring metrics detailed above and be more generalist in nature.
Research tools
The space is constantly evolving and there are a variety of fund research tools available to help. The free-to-advisers resource, https://www.fundecomarket.co.uk/, is a good starting place and covers a wide range of criteria you might use to filter for ESG funds. It can also hone in on specific fund aims such as positive impact and so can help filter based on a subset of ESG if needed.
For those with specific ethical inclusions or exclusions, the fund research tool provided by https://www.synaptic.co.uk/ is extensive in the inclusionary or exclusionary options you can filter with.
The Morningstar Sustainability Rating given to funds as well as the MSCI ESG rating (soon to be shown within FE Analytics) are third party ways of checking the relative ESG credentials of a fund.
It is important however to bear in mind there is not (yet) a standardised right and wrong approach when it comes to advising on ESG funds and portfolios. Third party ratings in particular may conflict with each other depending on the standards used and the relative weighting given to certain areas of ESG.
A good research trail is important here. Evidencing an understanding of what the client needs (or doesn’t need) is likely to lead you towards being able to demonstrate you have taken these needs into account with the research of ESG investments.
As with anything it’s about keeping the client and their financial goals in mind while completing the research to ensure that the advice is suitable and the investments appropriate. ESG investing is a hot topic, but it doesn’t mean that suitability becomes any less important. In fact with ESG, detailed research to evidence why a certain investment has been chosen for the client is paramount.
