Written by Neil Hill for FT Adviser.
More than 8 in every 10 investors (82 per cent) want their investments to do “some good” alongside generating a financial return. This is an enormous opportunity for financial advisers, but the challenge is exactly what “some good” looks like.
Many advisers meet this consumer demand with portfolios that use negative screens: investing by avoiding certain controversial sectors and businesses.
Presumably, the idea here is that avoiding bad is the same as doing some good. Which it nearly is.
Other advisers navigate the complex array of options by using differing shades of green as a proxy.
For example, a light green shade might be passive investments that track an environmental, social and governance-focused index, through to a dark green shade that represents active impact strategies. The darker the green shade, the greater the commitment to sustainability.
The big challenge with all these approaches is that it is very hard to work out whether any one of them is really meeting the clients’ demand.
The current solution to “some good” is often not that good at all
It is straightforward to look at popular ESG passive options being used for clients who are interested in doing some good and then pull them apart.
The top 10 holdings of most trackers are publicly available, and they often hold oil and gas, alcohol or tobacco businesses.
Last month, Tribe Impact Capital was asked to look at one adviser firm’s default option, which was a popular index tracker whose largest holdings included both the world’s largest deforestation lenders and the world’s biggest plastic polluter.
Where else do we use “some” as a measure?
To approach this problem from a different angle, imagine if investors had been asked about their risk appetite.
Almost all investors will explain that, given their return expectations, they want to take “some risk”.
The most appropriate solution used across advisers is to create a portfolio that combines both riskier assets with low-risk assets. Or equities, fixed income and cash, respectively. Each asset has a particular role to play in delivering measurable risk and return.
Few would offer portfolios to clients with varying degrees of “some risk” by using one asset class.
Perhaps you could build a medium-risk portfolio using equities by blending high and low-risk equities.
This does not feel very efficient, but it is the equivalent approach that many take to doing “some good” with portfolios.
Therefore, by taking a more sustainable approach, client demand will be more directly matched, and advisers can be confident they will be meeting their fiduciary responsibilities.
Build a portfolio with strategies you can evaluate
When it comes to delivering a portfolio with some risk, industry practice is to rely on blending riskier assets with low-risk assets. This way, each investment can be judged on delivering both returns comparative to risk taken.
When it comes to sustainability, one approach is to offer clients a solution using differing shades of green.
But how can the adviser evaluate the effectiveness of the “good” being delivered if the solution includes plastic polluters and deforestation funders? This seems like offering a medium-risk strategy with only equities.
A simpler solution is to build a portfolio that uses both a traditional strategy and a sustainable strategy.
Adjust the allocation to each strategy depending on the client’s demand for “doing good”. This way each strategy can be judged on delivering both returns and good.
Ignoring the question is not an answer
Of course, another approach is to avoid asking clients about their preferences.
Apart from the obvious problems with this approach, the urgency for advisers is that the Financial Conduct Authority has already asked the questions through its Financial Live survey in May 2022.
The FCA found that 81 per cent of investors with more than £50,000 say environmental issues are “really important” to them (up from 75 per cent in 2020).
86 per cent said businesses have a wider social responsibility than just making a profit.
In the same study, the FCA found only 23 per cent of those sampled have ever used any type of responsible investment.
Compared with the 82 per cent who want to do some good, this indicates that there is a 59 per cent advice gap in the UK population who would benefit from professional advice about sustainable investing.
