Ida Svensen, ESG Product Specialist, Vanguard

 

  • Over time, ESG investing has come to mean different things to different investors. With this in mind, financial advisers may find it useful to determine their client’s ESG objectives at the outset.
  • When financial advisers understand a fund manager’s approach to incorporating ESG considerations into product design and investment processes, this will help to build a more complete view of the fund manager’s overall ESG capabilities.
  • Understanding how an investment strategy could impact the outcomes of a portfolio will help financial advisers explain the risk, performance and ESG characteristics of a product to clients.

 

Investors around the world are increasingly interested in aligning how they invest with their environmental, social and governance (ESG) preferences and financial goals. Over time, however, ESG investing has come to mean different things to different investors.

With this in in mind, we share below questions that financial advisers may find useful to ask in order to determine their client’s ESG objectives, how ESG considerations are reflected in a portfolio and whether the fund and provider as a whole can meet a client’s ESG objectives.

What are your client’s ESG objectives?

For clients who indicate a preference to align their investments with sustainability/ESG preferences, you may first want to understand what specific environmental, social or governance issues they are concerned with. For example, a client might lean towards wanting to decrease exposure to high carbon emitting companies or avoid exposure to controversial weapons1.

After determining what environmental, social or governance issues your clients are concerned with, you may then wish to understand their objective in addressing them.

Some investors are looking to align their investments with their personal preferences, in which case they may wish to exclude certain sectors, securities or issuers that are not in line with those preferences.

Alternatively, your client may be seeking to generate a financial benefit, such as enhancing risk-adjusted returns or reducing certain types of risk. For instance, an investor may want to invest in renewable energy companies because they believe they will benefit from the transition to a low-carbon economy.

Other investors may want to effect meaningful change on a range of ESG issues. For example, they may aspire to support climate change adaptation and mitigation or influence a change in working conditions for employees of certain companies or sectors.

The ESG issues that your client is concerned with and how they want to address these issues will help you identify which ESG funds meet your client’s objectives.

How does the fund manager embed ESG considerations into their investment processes? 

Financial advisers might find it useful to understand their fund manager’s approach to incorporating ESG considerations into product design and investment processes. This will help advisers build a more complete view of the fund manager’s capabilities in implementing their ESG investment strategy.

Typically, fund managers integrate financially material ESG considerations into their financial analysis across all funds (ESG and non-ESG labelled). For example, equity or credit research analysts may identify and incorporate ESG risk factors—from macroeconomic factors to issuer-specific considerations—into investment decisions.

One way to understand how a fund manager is integrating ESG considerations is to review the manager's firm level disclosures, such as reports or risk policies in alignment with the Task Force on Climate-related Financial Disclosures (TCFD). It’s also worth asking if the firm’s investment team has people with the right expertise in place and if the company provides any training to ensure they keep up to date with industry developments.

A further consideration is how the fund manager uses ESG research and data in their investment decision-making process and whether they use ESG ratings. Getting a more holistic overview of how ESG is considered across the investment operation is therefore valuable when assessing the credibility of a firm’s capabilities.

Does the fund objective align with the client’s investment objective?

Understanding the objective of the fund is crucial to ensure it matches the client’s investment preferences. Understanding how the investment strategy impacts the outcomes of the portfolio will help you to explain the risk, performance and ESG characteristics of the product.

For example, many ESG strategies employ exclusions as a baseline which may lead to an under- or overweight exposure to a specific industry or sector, which ultimately can affect the risk and performance profile of the fund through different market periods. Further to this, there are fund managers who employ ESG scores to screen out companies or tilt the fund’s exposure towards companies with a higher ESG score. Ultimately, this approach can lead to higher concentration risk and a reduction in diversification compared to their non-ESG labelled equivalents.

These questions are not meant to be exhaustive but in recognising that there is no one-size-fits-all approach to ESG, they can help financial advisers assess the ESG objectives of a fund, the degree to which ESG considerations play a meaningful role in the investment process and gain a more holistic understanding of a fund manager’s approach and capabilities within ESG.  

 

1 The Sustainable Finance Disclosure Regime (SFDR) Principal Adverse Impact indicators may be used to understand what environmental, social and governance issues your clients are concerned with.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Important information

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The information contained in this document is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

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Issued in Switzerland by Vanguard Investments Switzerland GmbH.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

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© 2022 Vanguard Investments Switzerland GmbH. All rights reserved.

© 2022 Vanguard Asset Management, Limited. All rights reserved.