Getting your (green) house in order

Head of UK Wholesale Fergus McCarthy chats to Strategic Partnerships Director Dave Fewtrell about responsible investing, the rise of related regulation, and the impact on advisers.

Dave shares some of his recent experience of working on sustainable centralised investment propositions with advisers. In his view, best practice considerations can be summarised under three headings: Educate, Engage and Evaluate

Transcript

Fergus McCarthy: Hello, everybody, and welcome to the Thinking Out Loud podcast. My name is Fergus McCarthy, I'm head of UK Wholesale at abrdn, working directly and supporting financial advisors in the UK. In this episode we're going to talk about ESG sustainability, responsible investing, the rise of regulation on this theme, and ultimately how we believe this will impact financial advisors in the UK. 

And I've been sending investments we are fully committed to ESG and responsible investing, I have a range of solutions to meet you and your clients needs. At the end of the podcast, we'll share details of a new advisor guide that we've created, which focuses in on responsible investing regulation and considerations for advisors in developing their own responsible investing propositions for clients. 

As you'll be aware, interest in responsible investing solutions has grown considerably over the past few years, to the point that is becoming a mainstream consideration for advisors and their clients. We can see this coming through in terms of new investment flows into ESG related funds took twice as many assets in 2020, as they did in 2019. And this trend continues a pace throughout 2021. 

Joining me today to discuss these topics and share insights in the direction travel for our market is Dave Fewtrell, who is Strategic Partnerships Director at Aberdeen Standard Investments. Dave worked with me and the largest advisory brands in the UK market, as well as the major distributors and the platforms. Dave, welcome to Thinking Out Loud podcast. 

Dave Fewtrell: Thanks, Fergus, great to be here. 

Fergus: So to get us started around the context of ESG, and the rise in this theme, where do we find ourselves now? And what has driven us to this point and where do we see the strong growing narrative around sustainability? 

Dave: Yeah, so I would say generally, there is an increased awareness and trend towards sustainability within society, naturally, that flows through to the advisory world. We see this on the news, social media, general conversation is kind of all around us even you know, we can overhear it in the pub, when we're allowed to go there. 

So essentially, this conversation around sustainability is becoming a bit of a new hygiene factor. And, you know, historically, this, this conversation has been a societal trend around environmental concerns. And that's mainly been sort of driven by climate change considerations. And that I think is only really going to increase as we go forward, I mean, you know, we've got the Paris Climate Change accord which sets some pretty strong targets to mitigate climate change and the challenges that come with it. As it stands at the moment we’re not doing particularly well in hitting those targets – I think only Western Sahara and Morocco are on track to the 1.5 degree targets that have actually been set by the approach of that climate change accord. Increasingly, we’re gonna understand that there’s more work to do and increasingly, you know, clients, retail investors are going to become more engaged this societal narrative and thinking about how they can actually make a difference.

Not only that but beyond that we’ve got policy makers obviously understand there are some significant impacts of things like climate change – although its not obviously just about that – but, you know – potential global economic impact is pretty significant, something like 5 or 6 times of what we saw under the global financial crisis but stretched over a significant and prolonged period of time, so pretty painful if we don't get this right. 

You know, beyond that, of course, the wider considerations around climate change are pretty catastrophic, too. So certainly, I think, you know, individuals are going to be increasingly engaged in bringing forward their thoughts around sustainability, as well as policymakers in bringing forward reforms. 

And in addition to that, I would say, you know, increased disclosure, there is definitely a desire to see more of that, and that has been sort of unfolding for a number of years. And, you know, essentially, we see that fueled by the democratisation of information, you know - social media, you know, everyone has a phone camera once essentially has a computer in their pocket. And we essentially can broadcast things that you either do like or don't like, and if you have strong feelings about a certain sustainable theme, you can post that, do a video of it, put it on social media, and it can go viral very, very quickly. 

And a good example or simple example of that would be, you know, the decision to you know, recycle a single use plastic bottle here in the UK, you know, on social media feeds, you can see the impact of that decision where, you know, if you didn't do that, you might be able to see a UK market Coke bottle, for example, washing up on a faraway beach as a result of the decisions we make here in the UK. So very much a front and centre thing as a result of that information feed being right in our - essentially front and centre - in our mindsets. 

So, against that wider backdrop, bringing this all back together again, is this, you know, increased interest in sustainable thinking, sustainable living, sustainable purchasing. We see adverts further on this sort of narrative as well. And essentially, the next logical step is for clients to consider their investments from a sustainability point of view. So, this really in addition to what we've seen into the institutional world where institutional investors have rebalanced their portfolios to incorporate ESG considerations into their decision making, where they're looking to just mitigate risks, or maybe identify opportunities, we're going to see a greater array of individual retail products, which is going to naturally fuel the growth in this area, as investors become increasingly engaged in this societal narrative. 

Fergus: Yeah, thanks Dave, I'd certainly agree with that. And certainly, the advisors, I know that we work with are experiencing this theme really coming through from their clients, and that real need in everyday life to do better in terms of the environment in tackling climate change, it is increasingly becoming a part of the conversation that clients want to have with their financial advisors and planners. 

I just wanted to pick on the point you made about policymakers and regulation. We can see within the UK, essentially a reprieve for advisors, certainly in the short term anyway, in being obligated to discuss sustainable preferences for the time being. What can you tell us about the latest in terms of the regulator's current positioning on implementing these challenges and changes in the UK. 

Dave: Yeah, so I mean, clearly, from an advisors point of view, it's an important question, you know - how much do we plan and make appropriate changes to our processes and how do we start to integrate this into the conversations we have with clients? 

The simple, and probably an unsatisfactory answer, as it stands at the moment is the, it's kind of up in the air, the FCA are considering it as we speak. I think there's, it's quite a complex issue and there's a lot of underlying context and certainly, you know, when we think about it through the, the lens of the reforms that have already been rolled out, over in the EU, you know, we've got the package of reforms - they're called the EU Sustainable Finance Action Plans - which, you know, it's a huge and wide reaching package of reforms that are changing the landscape, and essentially giving the EU a great opportunity to wave the flag around their own sort of green credentials. So, you know, naturally, there's, there's, there's some core themes at the heart of what, what they're rolling out over there, which is, you know, they're trying to engage the financial system in the fight against climate change to tackle the things I sort of mentioned earlier, the challenges we've got there. 

They want to encourage investors to just think a bit more longer term with their money and invest, you know, for a more sustainable sort of - in a more sustainable way. And crucially, they want to improve transparency to mitigate and hopefully remove the wider greenwashing issue. So this is the wider context, which means that I think, regardless of whether we've got reforms coming immediately, or soon, that the direction of travel is very much there. 

And you know, the wider package of reforms we've seen in the EU, includes those MiFID II amendments that would introduce the need for advisor to discuss sustainability preferences with clients, as well as we've got a significant package of new disclosure regulation in the EU - the Sustainable Finance Disclosure Regime or the SFDR. Both of those things alone have added a significant amount of additional governance to the desks of financial advisors working in the EU with EU clients. 

So even though it's not in the UK at the moment, it is pretty clear that's the direction of travel. We saw Rishi Sunac stand up in the Commons back in November, and was very, very bullish about our own green credentials and ambitions. And in his Mansion House speech in July, once again, very, very bullish and effectively stating that we should expect a similar set of regulations here in the UK, which will also include a UK taxonomy as well, a green taxonomy. So, he told us to expect, you know, the UK version of the sustainability changes for advisors, and also Sustainable Disclosure Regulation as well. So, the question, of course, is, when will we see this, when should we actually start to make changes to our business. Well, essentially, the wider context there is kind of Brexit and you know, that does afford the UK Government a bit of an opportunity to sort of, you know, put their foot on the ball essentially, and properly just think about how they can implement something that's actually fit for purpose for the UK market, and perhaps a little bit more bespoke of what we would have just automatically on-shored where we still part of the EU. 

So, although it's very easy, and it could be the simplest thing for the government to just sort of copy and paste the EU regulation, I think we'll see some tailoring and I think that, you know, maybe around, you know, good client outcomes that could see some tailoring and some tweaking around that. But probably, more likely, given the context of leaving the EU and how that process went, we might see the rules being tweaked slightly to give us a bit more of a competitive advantage as we go forward. 

So the FCA are going to consult on any changes of the handbook, of course, as a result of any new legislation that the government proposes. 

Fergus: Great, thanks for that. David. I can certainly concur with your thoughts there and anyone listening to the podcast, I would say to you that, having seen the experience that some of my European colleagues have had in this regard, it's very well worthwhile making sure that you get ahead of this as firms thinking about how you're going to incorporate the sustainability elements into your centralised investment propositions - so do watch this space closely to ensure we get good sides on that. And you can of course, follow Dave Ryan on LinkedIn and indeed Aberdeen Standard Investments where we'll be posting regular updates on this as we get more visibility on them, so that we're in a position to be able to help you and your clients in terms of thinking about those sustainable elements within your centralised investment proposition. 

Okay, so shifting the theme slightly then Dave. In my travels with advisors, - they've been largely sort of virtual over the course of the last 12 months, of course – but even before then, seeing advisors face to face, it was very apparent that we have a lot of the financial planning community and advisors still on the journey, in terms of where the origins of engaging with the wider ESG responsible investing theme. What would you say to these financial planners do you see the challenges and objections that you see from advisors who were looking at responsible investments, and, you know, what would you say in response to these? And how could they perhaps think about overcoming them? 

Dave: Yeah, first and foremost, I would agree that what he's saying around that some advisors are still on a journey. On the flip side of that, there's, there's many advisors have really grasped this, you know, 1,2,3 years ago, and really excelling at it as a result. So, I think in terms of objections, there are still some and some challenges which we still get in conversations. 

The first one would be the sort of performance trade off perception, still remains to an extent. The idea that you must be giving up some return in order to invest for good. And this issue really isn't borne out in multiple research papers, forecasts on scenarios and empirical evidence. And what we do know is that by utilising those ESG considerations, you know, that additional information advantage in the investment process, means that funds and investment managers are aiming to essentially avoid bear traps in the woods, by investing in, you know, poorly run companies. So, by understanding what's going on in the company, you can make a decision on whether you want to invest in it for the longer term – it essentially just flows through to evidence that this bringing ESG considerations into that process does deliver more consistent and positive outcomes. 

Another one of the challenges that advisors have asked me about and told me about really, I guess, is how you deliver responsible investing whilst conforming to required attitude to risk. So essentially, you know, working a CIP around responsible investing, and still covering the obligations around risk. So I guess, first and foremost, I think it's important to understand that there is a significant spectrum of responsible investing products and solutions out there from values based ethical funds with exclusions, you know, top down thematic funds and impact funds as, and, of course, sustainable funds as well, you know, one size does not fit all, and, you know, they all have different attributes that will be, you know, specific to different client needs, which is great. And I guess the point being is to be a responsible investor doesn't mean that, you know, suddenly a client wants or demands that 100% of their portfolio is invested into an impact fund, for example, or an ethical fund. Clearly, there is a need to be proportionate and understand exactly what the client's needs and objectives are.

I suppose, in respect of the adviser’s process around suitability and the obligation to cover that attitude to risk, you know, adding that additional dimension of responsible investing into the CIP side of things is potentially a bit of a challenge if you are running multiple portfolios, and you want, you know, the widest possible universe of individual funds. And look, I would say that, you know, as time goes on, there will be an increasing opportunity set of new funds to populate asset allocations which match those clients attitudes to risk, of course, but if you feel that that's not, we're not quite there yet, clearly, you can, you can have a proportionate approach of adding some responsible investing funds alongside what you're doing at the moment to get your portfolios, perhaps on a journey. But that would be very much dependent on how you want to run your CIP and your views as a business of course. 

So given the layers of complexity here, it stands to reason why many advisors are looking to outsource here and use ready made risk profiles or outsourced solutions to cover those obligations from a risk and attitude to risk perspective, as well as providing those responsible features that meet those client's needs. And obviously, it also ticks the box from a PROD consideration as well. 

Fergus: And you know, in terms of asset management, you know, the long sort of debated ‘active this, passive that’ and of course, I think where we've got to today where we see these, these solutions that financial advisor’s using, whether they're combining both active and passive - how does that get impacted through the responsible investing lens do you think? 

Dave: Yeah, I think it's probably it's probably not a binary issue, you have to think about it a bit more. So I would say both have a part to play, ‘both’, in terms of the active and the passive space. When we think about ESG, in this way, it's not about just investing for ESG - it's how you invest, how you actively, you know, own the stocks, how you engage with the companies as well. 

So, you know, thinking about it through the lens of sort of pros and cons around this active/passive debate at a high level. Typically, in the passive space, you would see systematic exclusions or tilts on the portfolio based on particular ESG criteria that's going to enhance an ESG score, for example, and that is a great way of getting exposure to investments that are doing ‘less harm’ at a lower cost and reports, look, you know, cost is naturally a benefit of the passive side of things. The challenge, of course with going down this sort of exclusions route, is it might mean that you're not necessarily engaging with companies or lobbying on best practice and trying to steer the narrative with them. And look that is very much dependent on the asset manager you're talking about - so there's a real due diligence point there. 

And you could also argue that, although you're delivering that good ESG score in your portfolio - based on maybe some like lower carbon, for example - you may not be doing a great deal in terms of solving the problem. So you could, you could be excluding companies that have a higher carbon footprint, but these companies are actually building solutions, which are going to reduce carbon in the long run, and enable other companies to have a lower carbon footprint, for example. So it's very, it's important to sort of understand some of these nuances.

In the active space, naturally, they've always got the additional information advantage that you get. And you see that in the sort of, you know, the additional depth of research that you get into companies, you can actually get that activation. Of course, that costs more than being passive, but that's, you know, that's, you know, a natural scenario you get with an active/passive debate. But as a result of that, the value gets you get under the bonnet and see the risks and opportunities. And you can, you can kind of pick and choose naturally. So the active end is where you're more likely to see thematic and impact funds and a good example would be because essentially, you could buy those sorts of stocks, or companies in a passive, of course, however, down the sort of thematic and impact end  it's more likely, you'll come across smaller, smaller companies, essentially small cap companies, and therefore, potentially those come with an additional risk premium that you need to consider. 

So once again, that additional advantage of understanding what the company is what they're doing, means that you can identify the right companies in the space and avoid the ones that you don't really want to be investing in. So for me, I think it's a balanced view of the active/passive debate is, is required. And naturally, that's got to be aligned with your house view as a business as an advisory business, your ideology around that, and equally, look your client's needs and objectives and what you're actually trying to bring to them in terms of those propositions. So, it's not a binary issue, when you look at it through the ESG lens, it's not a ‘four legs, good, two legs bad’ to quote Orwell, I think you just need to weigh up the pros and cons of each approach. 

Fergus: Yeah, that's great. Dave, and I would thoroughly agree there. I think for those listening, get really thinking about and, you know, challenging your investment managers that you use in terms of funds to really evidence how they're, you know, doing this sort of active engagement, I think is really going to be key - and something that we're gonna have to evidence as part of building these investment solutions for clients. 

So we're seeing sort of the growth of the risk profile solutions in the space becoming increasingly popular again, back to Dave, the point you made about advisors thinking about how they can deliver responsible investing solutions as part of a scalable CIP. And we know that in the market today there those that insource and those that outsource those kinds of solutions. And on that note of advisor processes, if we were to offer some practical considerations for advisors to go through when building or developing a responsible investment proposition, what would they be based on? And what do you see, given the experience that you've had, particularly with advisors on this over the course of the last 12 and 18 months that you see really is what would be best practice in the market currently? 

Dave: Yeah, so certainly, look, based on the firm's that we've been engaging with, and the ones that have really picked up with this and kind of run with it and started to excel with it over really two or three year period really, is, the best practice considerations can essentially be summarised under three headings. So, you know, Educate, Engage and Evaluate, I guess, would be the three things - so three words beginning with E, which is nice and easy to remember. 

Educate, that first one would be kind of an obvious point, but clearly, it's important that advisors you know, embrace the ESG theme, the narrative and ensure they're comfortable with it and, and naturally be really important with the context of not just the technical product side of things, but the wider kind of societal narrative, the trade offs, what you know, what this stuff actually means. As an advisor, clearly, you have TNC considerations and it's important to understand that wider current environments regarding that responsible investing piece, but of course it's really important you feel comfortable incorporating that discussion into the engagements with clients. 

And I understand that, speaking to clients is a bit of an art form, it's making that technical, when that difficult sort of technical discussion, quite a nice, easy conversational thing. So be thinking about that ahead of time is really, really important. And, of course, you know, when you're actually sitting down with those clients, you know, it's important to understand that responsible investing can be a very personal and subjective concept. 

So some clients might be really binary in their thinking, and what to exclude things. They might, you know, certain clients might just be want to be really completely focused on climate change, for example, and that might lead you a certain way. Equally you could have clients that don't actually have really, really strong views but they want to feel like they're doing their bit. So kind of, you know, a little bit of the kind of the middle ground sort of approach. So I think, you know, it's important to understand they're very much different shades of responsible investing and clients can have quite different views. So it's a little bit like the paint palette that you see down a DIY shop, there are very many different shades of green to choose from. And it's important that we can help clients understand what that all those different shades actually mean. 

So that's Educate, the second one is Engaged, as I mentioned. So I think it's all about how we speak to clients in everyday language. And, you know, essentially, what we're talking about - that we've seen is really good best practice from the market - is thinking about just making it a bit more real. So terminology is a challenge, you know, what does ESG actually mean to you know, a normal person in the street and normal retail clients - you know, probably not a great deal. 

So, being real in our language to help breed understanding is really, really, important, and just getting that conversation going. And in the same way that advisors have to assess clients knowledge, experience, understanding of, you know, investment, risk, capacity, philosophy, that sort of things, it's important to test, you know, ask clients testing questions, and then be, you know, be prepared to actually challenge the responses that you get from clients to really dig into the trade offs that they're willing to make and what they're not willing to make. And that will obviously help us get closer to what is the most appropriate solution for them. And, of course, it's important to understand that, you know, clients attitudes to this sort of thing can change over time, and that might be just because the societal narrative becomes more important to them around sustainability, and they just get, they kind of get their behaviours changed  as a result, or it might just be, you know, demographically, they move through the age ranges, and that just changes their views anyway.

The last one is Evaluate. So, you know, best practice in the market is seen is, you know, a good review of processes. And, you know, ahead of time before, essentially, the regulator tells you you have to essentially is what we've seen. So, you know, best practice we've seen is, you know, thinking about how you review things like suitability letters, you know, at what point do we start to put an explanation in to those around how our clients objectives and needs can be achieved by taking into account sustainability preferences. Thinking about things through the lens of PROD, you know, understanding the needs of the target market and aligning solutions which meet those needs, and which, you know, essentially becomes a conversation about segmentation. Thinking about, do you segment clients within your business? And if you're going to do that, do you have a, you know, compartmentalised sub segment for responsible investing? Or do you try and overlay responsible investing across what you're doing at the moment, in terms of propositions? 

So only you as advisors can really think about that through the lens of their own business and understanding that, but it's just something to think about well ahead of being sort of obligated to do it, by the regulation that we do know, is actually coming. 

And of course, you have to review your Centralised Investment Proposition to ensure that, you know, existing fund solutions, platforms in outsourced investments, you know, all those sorts of recommendations are able to meet stipulated investment, sustainability preferences of clients.

Fergus: Great stuff Dave, really good practical stuff there and I know from some of the feedback that we had, when we were out talking to advisors about this, you know, certainly at the sort of the turn of last year - and indeed, throughout the year we had the opportunity to - I know that this practical stuff, these considerations that we talked, have gone down really well with financial advisors and planners. 

And really important that point there that you mentioned around evaluating the business processes and continually assessing the range of funds that are available. I think the one thing we do know is that the market is evolving and selecting the right partner that shares the same values as you and your clients to is really, really important, and indeed a partner that can be flexible Dave to your point around thinking about that range of different outcomes, those range of different shades of green that every client will have because of course all clients are not created equally. 

I would add to that starting point for advisors, is to identify where they want to be and how they want to be viewed and to go from there in terms of working through the next steps of building or developing a responsible investing proposition for clients.

And Dave and I and the team here at Aberdeen Standard Investments are here to help you with that wherever we can do. So if you listen to this podcast and thinking, you know, now is the time, or indeed I'm already well through this sort of thinking about my sustainable, Centralised Investment Proposition, but I can still do with talking to somebody about it, then we'll be very happy to have a conversation. And on that point, I mentioned at the beginning of the podcast that there was going to be an advisor guide which picks up on some of the things that we've discussed today. And this guide covers the regulatory environment practical steps you can take to build or develop your own responsible investing proposition - as well as considerations around your diligence - if you want to outsource your Centralised Investment Proposition to purpose built, ready made, solutions based, risk profile solutions. The outsourcing theme is naturally a consideration to discharge obligations around your clients attitude to risk while serving as sustainable features of exclusions, investing in better companies, and indeed impact solutions to deliver a better future for all of us. 

Do speak to us, do please speak to your usual Aberdeen Standard Investment sales contact for more information or indeed get in touch with Dave and I directly. And it'll be great and we’ll be delighted to support you in this area. In addition to the guide, of course, at Aberdeen Standard Investments we'd be very keen to talk to you about our wide range of investment solutions in the responsible space from ethical funds, thematic funds, impact funds, and of course, mainstream sustainable funds, and climate funds as well. 

And in the space of course, we have the MyFolio sustainable range, and we'd love to speak to you about that more in due course as well. But all that remains for me to say that on this very warm day, summer day in July, thanks very much for listening to this Thinking Out Loud advisor podcast and to Dave for joining me and sharing with me - and hopefully with all of you - some of the experience that he's been having with advisors thinking about those sustainable Centralised Investment P ropositions. 

Many thanks, good luck and if we can indeed be of any help, don't hesitate to get in touch. Goodbye