How number of new solutions and frameworks pose challenges for both investors and advisors
Over the past two years, the landscape of ESG has undergone tectonic changes.
The idea of doing good by doing well has captured the imagination of investors across the world. Enthusiasm has built around themes like green energy and the net-zero transition, giving rise to a whole new universe of investment solutions. But that growth has come with real challenges as well.
“We quickly went from an environment of very little choice in terms of true sustainable, ESG, or responsible investing, to an absolute abundance of choice,” Sonia LeRoy, senior wealth advisor at LeRoy Wealth Management Group with IPC Securities, told Wealth Professional. “That has led to confusion on the part of investors, and people not necessarily investing in what they’d hoped to invest in.”
Rather than build brand-new ESG funds from whole cloth, some asset managers give pre-existing investment funds a second life with an adjusted mandate and an updated green identity. Alyssa Stankiewicz, associate director of Sustainability Research at Morningstar, argues there’s a risk of investors not understanding what ESG factors are taken into account in the investment process, and what level of impact a new sustainable investment mandate might have.
“When it comes to the proliferation of these ESG products, I think the risks come mainly from the question of investor understanding, as well as asset manager transparency and disclosures about the nature of the changes and the impact,” Stankiewicz told WP.
To help avoid that outcome, regulators in North America have been stepping up their efforts to help ensure ESG funds’ underlying strategies are aligned with how they’re communicated to investors.
In guidance issued January this year, the Canadian Securities Administrators (CSA) clarified its expectations around ESG products with respect to fund names, investment objectives, investment strategies, sales communications, and other aspects.
In May, the US Securities and Exchange Commission proposed new rules that would require SEC-registered advisers to include ESG factors and strategies for investors in fund prospectuses, annual summaries and brochures; the proposed rules’ impact on a fund depends on whether it’s categorized as an integration fund, an ESG-focused fund, or an ESG impact fund.
The Canadian Investment Funds Standards Committee (CIFSC) also published a Responsible Investment Identification Framework in July. The framework is meant to help Canadian investors find products that suite their non-financial investment preferences, and acts as a complement to the CSA’s guidance as well as the CFA Institute’s Global ESG Disclosure Standards for Investment Products.
With the risks of misalignment so high on both sides of the suitability equation, ESG poses a multi-pronged challenge for advisors. Not only must they become proficient in an evolving language of investing, metrics, and frameworks, but they must also act as matchmakers who understand their clients’ priorities beyond financial objectives such as wealth accumulation and income.
On the KYP side, Stankiewicz argues it will likely fall to advisors to learn more about the different ESG approaches available in the current landscape, and the nuances of what each ESG product does.
“At the end of the day, greater fund disclosure is a plus. It gives advisors and investors something tangible that they can rely on – especially if it’s being audited by a regulator – to understand what these funds are doing,” she says. “That said, it’s definitely a challenge for advisors and investors to understand where things are moving as definitions are still being worked out and disclosure expectations are still evolving.”
For advisors, embracing ESG also means beefing up their KYC processes to create a fuller profile of their clients as ESG investors.
“The role of advisors is to help clients really identify and articulate what their values are, and what they're most passionate about, then look at the complex landscape of what's out there, and go through a process of elimination to find what aligns with what their clients want to achieve,” LeRoy says.
This is a condensed version of a sector focus piece that will appear in the upcoming Fall magazine issue of Wealth Professional.