ESG now established as a key factor in investment decision-making
Investors are increasingly aware of the impact their investments can have on the world and are seeking to align their investments with their values. They are choosing to invest in companies that demonstrate a commitment to sustainability and responsible business practices, as well as companies that are transparent in their reporting and governance. These non-financial factors are becoming increasingly important as part of their process to identify growth opportunities and are increasingly appearing in annual reports or standalone sustainability reports.
Europe’s requirements for disclosing ESG classifications
Europe has led the way in demanding greater transparency in reporting from funds in terms of their ESG footprint. The Sustainable Finance Disclosure Regulation (SFDR), a European regulation introduced in March 2021, looked to improve ESG transparency in the market, prevent greenwashing and provide investors with greater insight into sustainable investment products. Managers are now required to disclose ESG classifications in three categories:
- Funds that have a sustainable investment objective (article 9 Funds)
- Funds that have social characteristics (article 8 funds)
- Non ESG funds (article 6 funds).
In essence, if a manager is launching a fund today and is making claims that align with ESG standards, the fund will be benchmarked and rated against their claims. This standardisation across European funds was welcomed by investors, allowing them to construct their portfolio in more considered ways than before. It is important to note that SFDR also applies to non-EU funds and non-EU managers that are marketing their funds into Europe.
The challenges of SFDR
Although welcomed, the implementation of SFDR is proving to be challenging for the industry. Claims of greenwashing despite the legislation persist. There is also a great deal of confusion driven by inconsistent data and significant problems in developing objective criteria with which to rate companies’ ESG credentials.
Des Johnson, Global Chief Revenue Officer at Waystone, says “There is no doubt that ESG considerations are now a key factor in investment decision-making for many investors. However, classifying and rating funds on metrics that are perpetually evolving from a regulatory standpoint is difficult. Although non-binding, ESMA’s supervisory briefing to domestic regulators promotes consistency and clarity.”
He continues, “Investors want to see companies that are not only profitable but also have a positive impact on society and the environment. We are still at the infancy of ESG for fund management and it is evolving. A major challenge in 2023 is supporting claims that ESG portfolios generate superior investment returns. We see ESG biased portfolios, often with large weightings in tech stocks, having a challenging couple of years, while environmentally unfriendly sectors, such as oil and commodities, have performed well. At Waystone, we are happy to see regulations such as SFDR in place. There has been a lot done, but still more clarity needs to take place as the industry evolves.”
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