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Four questions to ask when selecting a Sustainable Fund

Updated: Oct 21, 2021

On 19 Jul-21, the Global Sustainable Investment Alliance released its Global Sustainable Investment Review 2020[1].. Assets invested into Australian Sustainable Funds grew by 38% over the prior two years, despite ASIC narrowing the definition of sustainable investing. Australia is not alone and investment into Sustainable Funds in the US exploded 42% over the past two years. While these types of figures are always viewed with scepticism due to measurement difficulties, everyone with an even passing interest in funds management would know that sustainable investing is booming.


The funds management industry has embraced this growth by offering an ever-growing menu of Sustainable Funds. Many of these funds are true to label but there inevitably has been, or will be, a proliferation of funds that are designed to exploit the market rather than serve it. The most common forms of exploitation are ‘Greenwashing’ and over-charging.

We all understand over-charging, but Greenwashing is a more nuanced term. It means to present the veneer of sustainable investing through the fund name or marketing material, but not substantiating that with actions. This definition implies there are two parts to Greenwashing.


The first corresponds to the word ‘sustainable’ and it relates to the fund not investing in sustainable businesses or fulfilling their sustainable investing responsibilities. The second part is sometimes overlooked and relates to the word ‘investing’. The word ‘investing’ means that Sustainable Funds must also focus on generating worthwhile financial returns and not just filling a portfolio with ‘green’ stocks with bleak futures. A fund that does invest sustainably but without rational investment targets is as guilty of Greenwashing as fund that doesn’t prioritise the sustainability part of the strategy.


To separate the Greenwashers from the rest, we propose four starting questions.

  1. What are the fund manager’s sustainability rules and processes?

  2. What are the manager’s financial requirements?

  3. How transparent is the fund manager?

  4. What are the fees?

Sustainability rules and process

There are several flavours of Sustainable Investing, each require their own approach and focus. These strategies include, explicitly including ESG risks and opportunities in investment decisions and analysis, Negative/exclusionary screens, Norms-based screening, Corporate engagement & Shareholder action, Best-in-Class/positive screening, Sustainability themed/thematic investing, and Impact investing & community investing. All these strategies serve their purpose, and we will not suggest here which ones are better than the other. The key message is that there are several strategies, with different processes, which must be considered when assessing fund managers.


One way to assess a fund manager is to use Evergreen Consultant’s methodology, which we think is logical and practical. Evergreen apply their Responsible Investing Grade Index (“ERIG Index”)[2], which is a survey based approach that aims to evaluate the fund managers Responsible Investment (“RI”) intent and RI action.


We believe Evergreen’s approach, or ones like it, is an effective way to determine if the fund manager is fulfilling the ‘Sustainable’ part of Sustainable Investing. To incorporate this into your strategy we suggest reaching out to a reputable consultant and/or ask your fund manager for a clear explanation of their Sustainable Investing strategy and its targets. Finally, systematically compare this description to what the fund manager has done. The corollary of this is, don’t rely on a fund names or jargon filled descriptions.


Financial returns targets

Sustainable Investing requires solid financial returns to qualify for the investment taxonomy. As with all strategies, average returns are not good enough and you should not compromise your investment return expectations.


Returns are self-evident over time, but we don’t have the benefit of hindsight, so what should you do? As with all fund managers there is an art and science to making this assessment and it is difficult to offer a prescription of how to identify the ones capable of generating the target results. However, the great thing about assessing Greenwashing is that it is often straightforward to assess which fund managers are focusing on returns. Just listen to them.


Transparency

It is impossible to make any assessment of a fund manager without the requisite transparency. This is particularly prescient in Australia, which is ranked last out of 26 in Morningstar’s Global Investor Experience Study[3]. If local regulations don’t force disclosure we will need to depend on voluntary disclosures and we recommend you dig deep into this matter.


Some of the areas we would focus on include:

  • Does the fund manager have a Sustainable Investment (or similar) statement that clearly explains their sustainability philosophy and process?

  • Does the fund manager disclose the fund’s positions and how regularly?

  • Does the fund manager report its financial and sustainability/ESG/ethical performance and in how much depth?

Fees

Up to now we have focused on the Greenwashing part of Sustainable Investing exploitation and now we can consider the second part, fees.


Managing a Sustainable Fund does impose additional costs on a fund manager, such as professional ESG ratings and additional time and expertise to identify companies that are both ‘Sustainable’ and deliver solid returns. However, these additional elements do not warrant the premium prices we have observed in many Sustainable Funds.


The average management fee for the top three Sustainable active equity managers in Morningstar’s November 2020 report was 1% (Retail class). A broader search identifies that sustainable/RI/ESG/ethical funds often charge higher fees than their more traditional contemporaries and the fees even go as high as 1.7% (retail class).


We don’t believe the fee premiums are entirely justified and cost pressure is inevitable. Regardless, while we wait for the fee compression make sure you check Sustainable Funds’ management fees and be sceptical if the fees are materially out of line with traditional funds.


Conclusion

Sustainable Investing is a growing market, and we believe that this trend is likely to continue for good reasons. It is possible to invest money sustainably and generate solid returns with low fees. Given this possibility, why wouldn’t everyone seek Sustainable Funds? However, there are managers that won't deliver on both sustainability and returns and there is an element of caveat-emptor in such a booming market. We hope this blog will help you navigate this field and identify the fund managers that will deliver all your clients’ reasonably expected requirements.

[1] http://www.gsi-alliance.org/wp-content/uploads/2021/07/GSIR-2020.pdf [2] https://www.evergreenconsultants.com.au/main/media/ERIG%20Index%202021.pdf [3] https://www.morningstar.com.au/funds/article/aussie-funds-keep-investors-in-the-dark/208275

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