Pot Noodle is the Unilever-owned brand of “cup noodles”. Just add boiling water to your pot of dried vegetables, noodles and flavouring, and you have an instant meal. Beloved of students, detested by foodies, the Pot Noodle has been a staple of dietary culture since 1977.
Now, some investment funds are starting to look a little like a Pot Noodle: they have gained the ability to transform into something delicious through the addition of a simple ingredient, ESG. And the funds industry is starting to worry.
We wrote back in October 2018 about the inexorable rise of ESG – Environmental, Social and Governance – as a factor in investment funds, citing a Bank of America Merrill Lynch report showing that listed companies embracing ESG outperform their peers on many levels: total shareholder return, profitability and low volatility.
ESG as an Investment factor has exploded, with every fund management firm seemingly competing to out-green its peers. A whole industry has sprung up to measure, attest and ensure companies’ ESG credentials, and investors’ cash is pouring in to the sector. In the US alone, ESG investing reached $12 trillion in 2018.
The rapid and near-universal adoption of ESG and its relative Sustainability Development Goals (SDG, derived from the UN’s 17 sustainability goals) by funds, seems to show that the world of investing and indeed of business and capitalism itself has shifted to a moral high ground.
But now a backlash is beginning, and a new risk is emerging that has the fund industry worried.
A suspicion is growing that firms are simply re-badging or re-marketing funds as being environmental, social and governance-focused when they are not, and the suspicion is being aired with increasing volume and concern.
A great deal is at stake. Strict rules of disclosure govern the marketing of funds, and any investor who feels they were misled at the time of sale could seek regulatory redress at any point in the future. So if any investor – retail or institutional – buys a fund today that claims to abide by ESG principles, only to discover in future that it does not, that investor will have a strong claim for compensation.
The financial industry knows all about mis-selling: a scandal involving Payment Protection Insurance mis-selling by banks has resulted in total compensation of £33.8 billion ($26 billion) since January 2011. (Source: FCA)
It is fear of another mis-selling scandal that is driving the increasing number of voices warning of funds that are “greenwashed” – that is, given an ESG label without any underlying change in their make-up. Similarly, the UN’s sustainability goals, often used by fund managers and companies as a benchmark of their environmental credentials, were never designed to be used by financial firms. They are a set of principles to guide government policies. Some of them are simply inappropriate for funds to claim: No Poverty; Zero Hunger; Reduced Inequality: how will an investment fund deliver these? And if there is no chance of it ever being real, why is it used as a marketing slogan?
A survey of independent and restricted financial advisers by EdenTree Investment Management, an ethical funds business, found that 97% of the advisers surveyed were either “very concerned” or “fairly concerned” about the potential for mis-selling allegations, where a client becomes aggrieved their money is invested in a firm or fund they deem unethical, despite being labelled as an ESG investment. It also showed that 31% want “clearer, more consistent, and transparent product labelling”.
How will this play out? In the long run, we suspect this new scepticism will be beneficial. It will result in greater scrutiny of claims for ESG and SDG alignment; it will drive new and more accurate ways of measuring ESG performance; and it will result in investors demanding more rigour in the measurement of ESG claims.
But that will come at a cost, and the asset management industry is facing tremendous cost pressures. More proof of this came this week with the publication of a report by PwC showing that since 2012, Active fund fees have fallen by 8.6%, with PwC predicting a further 19% decline by 2025. PwC states the cost vs ESG dilemma facing fund managers very well:
“As managers seek to include environmental, social and governance (ESG) factors in their investment mandates, short-term costs are likely to increase due to the need to hire new talent, incorporate new data sets, and embed new policies and compliance and risk processes to monitor ESG criteria. But it’s essential that managers respond to what investors want and raise the moral purpose of the Asset and Wealth Management industry.”
It is partly these new costs driven by ESG compliance that has caused some funds to resemble the Pot Noodle. Take a fund, add a splash of greenwash, and voilà! A whole new client base is lining up to pay your fees.
Except this time, the Pot Noodle sellers are likely to be found out. Watch out for some bitter battles over ESG in the not too distant future.