Would you rather hug an index or a tree?

Posted on: December 9th, 2013

Would you rather hug an index or a tree?

Would you rather hug an index or a tree?

Solving the challenges around how to integrate the most important elements of ‘SRI thinking’ into portfolio planning tools may not happen overnight (even with a tree in every living room!), yet it is high time work began in earnest…

‘Environmental, Social and Governance’ (ESG) risks and opportunities are increasingly integrated into longer term business decisions, policy planning and institutional investment strategies – yet they remain low profile within the retail investment world. Their absence from retail investment tools means investors rarely have the option to bring such issues into their investment strategies and those with opinions on ESG matters are often poorly serviced by our industry.

There is clearly a growing number of people who understand and care about environmental, social and governance issues*, yet those who can articulate it in a retail investment context are few and far between.

The following are some high level thoughts which set out the challenges in the ‘individual investor’ world as I see them:

Challenges for advisers

  1. ‘Big business’ is increasingly focused on longer term ‘ESG risk’ however investment researchers, ratings companies and other service providers generally are not.
  2. As a result ESG issues often have little impact on the value of investments, particularly if they are considered ‘longer term’.
  3. As a result investment benchmarks (and other measures) are artificially skewed in favour of shorter term factors.
  4. Portfolio planning tools use these ‘conventional’ methods of analysis and so pass on information to financial advisers that is  based on ‘short term’ oriented analysis.
  5. With this information chain (eg share values, benchmarks and portfolio options) skewed towards short term issues it is questionable how appropriate such analysis is for financial advisers and their (normally medium to longer term) investment clients.

In addition, commentators often think of SRI options as a single, relatively homogenous group. This is misleading for both advisers and clients. Options such as ‘sustainability themed funds’ and ‘strictly screened ethical funds’ are very different. The former focuses almost entirely on ‘macro’ trends, the latter focuses more on ‘ethical values’. Although commonality exists, this makes them different in many respects, including where they invest. (The sriServices ‘SRI Styles’ classifications were developed to help highlight key differentiators).

 Challenges for SRI fund managers

  •  Fund managers who put significant emphasis on longer term issues can be effectively ‘selected against’ by third party analysts. This is because their strategies deviate from commonly used benchmarks and so may not meet assessment criteria.
  •  Funds that focus on ESG issues are therefore less likely to find themselves on buy lists or within portfolios that are proposed to clients by advisers.
  •  With little relevant third party analysis of SRI/ESG related options limited useful information is available to advisers (via portfolio planning tools and other service providers). As a result advisers are often reluctant to regularly advise on this area as such tools commonly form part of their business models.

The problem therefore is that whilst it may be defensible for people to focus on the ‘here and now’ in their everyday lives, this does not make sense for their investment strategies. Most retail investment products are intended for the longer term benefit of clients, say 10 – 30+ years, so ignoring longer term issues is counter-productive.

We may not know which risks (and opportunities) will impact longer term investors (and the world we live in) first or most; (climate change, resource depletion, water shortages, human rights ..?) but at the very least measurement, management and diversification would make sense for all investors.  Integration of such issues can also help provide consistency in within conventional risk measures – particularly as they increase in importance.

As such, moving away from the ‘them and us’, ‘tree hugging v index hugging’ status quo is essential.  Not only would this help us to serve investors better, it would also help grow trust of our industry.

A greater emphasis on long terms issues may contribute to a decline in the value of some of today’s largest companies, such as oil companies, but in reality most investors would probably prefer a gradual transition to an apparently ‘unforeseen’ crash. It may also help address some of the issues policy-makers and others are struggling with – and support companies with effective longer term strategies.

 So what can advisers do?

  • Clients. Identify which clients are interested in this area. Once identified, advisers need to understand their personal goals, risk capacity and opinions, as these will vary. Investments may then need to be reviewed accordingly. There are tips on how to understand clients needs on the sriServices website.
  • Fund Managers. Talk to fund managers about their views on ESG, SRI & risk. Information flow to advisers in this area is in part limited as a result of a perceived lack of demand. Advisers can help change this. If appropriate, suggest their SRI funds are risk profiled.
  • Service providers. Ask for ESG factors to be integrated into investment analysis and portfolio construction tools. Also, request SRI portfolio options.

Whatever your point of view, whether you like indices, trees or both,  we would love to hear your thoughts on this area, ideally via the brief SurveyMonkey questionnaire below.

 PS. regular readers of this blog may recollect that I am involved in a couple of projects that relate to this area, namely with Parmenion and with Rayner Spencer Mills. As much as I would of course like to promote the good work they both carry out, my wish, as ever, is for activity of this kind to be ‘the rule rather than the exception’! 

I look forward to reading your responses to our questions!


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*notably – those who run ethical and ESG style specialist indices – although these are not widely used in ‘retail’.

For further information on this topic readers might like to search the term ‘ESG risk’ on Google or elsewhere.