ESG: three confusing letters

If you ask someone you know working in the financial industry: “what does ESG stand for?”, they’ll probably be able to tell you - environmental, social and governance factors. But go a step further and ask them exactly what these criteria mean for investing, or what the difference is between ‘ESG’ and ‘sustainable’ investing, and lots will soon get stuck. This isn’t surprising given the lack of consistency in the language used by asset managers, regulators and the media on the topic.

What belongs in an ESG fund?

This confusion between the different ways to invest with environmental or social issues in mind has been highlighted once again as the war in Ukraine has unfolded. On the one hand, several articles have appeared expressing shock that some ESG funds hold defence companies or Russian government bonds and accusing them of ‘greenwashing’ (basically, over-egging their sustainability characteristics or benefits). And on the other, some have argued directly the opposite, claiming that the invasion instead highlights that there’s a positive case for holding defence companies in ESG funds because governments must rely on them to help protect civilians in times of war.

Of course, these are complex issues and can often come down to personal opinion. But one way to help clear up confusion is to start out by clearly defining exactly what you mean by ESG and then to ensure that your fund has a transparent investment process aligned with that definition so clients can decide whether it’s right for them or not. This is the approach our Multi Asset team has taken in distinguishing between our core Rathbone Multi Asset portfolios and our sustainable Rathbone Greenbank Multi Asset portfolios.

How ESG integration differs from sustainable approaches

Most of us know what ’ESG’ stands for, but it actually doesn’t mean much as a standalone acronym to describe an investing style. As we explain in our “Demystifying responsible investment” guide for advisers, there are several approaches and sub-approaches you can take when investing responsibly. One involves ESG integration which is what some funds labelled as ‘ESG’ will be doing. This involves systematically and explicitly including ESG factors into investment decision-making, alongside the usual financial metrics you’d consider when analysing assets, such as debt, cash flow and valuation. It’s important to realise that ESG integration doesn’t necessarily mean that certain sectors (like the defence industry) or government bonds will automatically be excluded.

Instead, it means thinking about the material ESG risks and opportunities that an individual company or government might face (i.e. those likely to affect the financial performance of the related assets), assessing their potential impact and then feeding this into the decision to buy, sell or continue to hold that asset. This is the approach we take in our core Rathbone Multi Asset Portfolios. ESG risks and opportunities for equities and bonds can change over time, as the market evolves, in turn affecting buy or sell decisions. But we don’t take a blanket exclusionary approach based on ethics or sustainability. Of course, we don’t label these funds as ‘ESG’ as to us ESG integration is just part of our robust investment process.

On the other hand, our Rathbone Greenbank Multi Asset portfolios are what we would call ‘sustainable’, and they take a different approach to considering environmental and social issues. Clear sustainability criteria determine exactly which areas these funds can and cannot invest in. Our exclusionary criteria seek to screen out companies creating significant negative impacts that are considered to be incompatible with sustainable development. We took the decision from the outset to exclude investment in any defence companies or oil and gas majors (among several other areas). Also, while we can invest in government bonds as an asset class, we have implemented specific sustainability criteria that our government bond holdings must meet to be included in our funds (these focus on criteria like the issuing governments’ civil and political freedoms, corruption records and their defence and climate change policies).

Funds labelled as ‘sustainable’ should be designed to support progress to a more sustainable world both through avoiding harm and by driving positive change. And our Rathbone Greenbank Multi Asset portfolios are aligned to the UN-backed Sustainable Development Goals (SDGs) which promote peace and prosperity for people and our planet. The SDGs specifically aim to reduce all forms of violence and related death rates everywhere. Therefore, to us, defence companies are simply incompatible with this objective and we think the majority of our clients would not expect to see them in a fund specifically labelled or marketed as ‘sustainable’. (Likewise, we feel that holding oil and gas majors would be at odds with the SDGs’ focus on urgent action to combat climate change.)

Why clarity is key

We recognise that these are complex issues and, of course, that clients will have personal preferences about the kind of assets they want to emphasise or avoid. But by trying to be as clear as possible about what we can and can’t invest in across both our Multi Asset ranges, we hope to help clients avoid any confusion and understand fully whether our funds fit their values before they make an investment decision.

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