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What Do Retail Investors Really Think about ESG Investing?

by Paul Golden
  • Brokers keen to improve access to environmental, social and governance (ESG) information.
  • Data shows mixed signals from retail investors.
  • UK anti-greenwashing rules to set a high bar on sustainable products.
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The biblical phrase ‘There is nothing new under the sun’ is particularly appropriate when applied to investments based on environmental, social or governance (ESG) principles given that the origins of ethical investment can be traced back to the prohibition on investing in businesses with links to alcohol, tobacco or gambling exercised by religious groups such as the Quakers in the 19th century.

Fast forward to the 1960s and movements such as opposition to the apartheid regime in South Africa spawned the term ‘socially responsible investing’ with investors becoming more sophisticated about the sectors and stocks they wished to avoid.

The first proper discussion of how to integrate ESG into investment decision-making was prompted by the UN’s 2004 ‘Who Cares Wins’ initiative, which described ESG integration as an important source of competitive differentiation and value creation for financial institutions. But, almost two decades later, recent survey data suggests that many retail investors remain ambivalent when it comes to attitudes to ESG investment.

“Customer exposure to sustainable funds is slowly creeping up,” says Interactive Investor spokesperson, Jemma Jackson. “What is interesting is that even after the year to date – which has been torrid for the sustainable funds sector due to a large exposure to growth stocks – this trend has continued.”

Morningstar’s latest quarterly global sustainable fund flows report found that sustainable funds attracted $22.5 billion of new net money in the third quarter of 2022, which is down from $33.9 billion in Q2, and the number of fund launches was also down.

Jemma Jackson, Interactive Investor
Jemma Jackson, Interactive Investor

Of course, these figures should be considered in the context of investor concerns over the global economy, inflationary pressures, rising interest rates, and the conflict in Ukraine. In fact, assets in global sustainable funds were down just 1.6% between July and September compared to a 7.5% decline for the broader market.

However, a survey of DIY traders and investors published by Capital.com in September found that more than half had never selected a stock or made a trade based on ESG criteria with only 7% citing social and environmental reasons as their criteria for making an investment decision.

Investors Pursue a Variety of Strategies

“There is definitely some enthusiasm for ESG investing from retail investors,” says Laith Khalaf, the Head of Investment Analysis at AJ Bell. “There has been significant growth in ESG fund flows in recent years, but within the UK they still only account for around 6% of total fund assets – and that is using a fairly broad classification of ESG.”

Cecile Fleckten, the Head of ESG and Sustainability at Interactive Brokers refers to the demand for both tracking indexes and investing in specific stocks, while Saxo Bank’s Head of Commercial ESG, Ida Kassa Johannesen, says clients are increasingly interested in ESG ETFs.

“The general zeitgeist in favour of broad diversification at low cost applies to ESG investing as well, making indices the most popular way for retail traders to institute ESG principles into their portfolios,” says Matt Weller, the Global Head of Research at FOREX.com and City Index.

Investors who prefer picking individual stocks most commonly use ESG as a ‘negative screen’, meaning they intentionally avoid investing in the stocks with the worst ESG policies, rather than proactively investing in firms that are seen as particularly ESG-conscious.

“Both tracker funds and active funds have been popular ways to access this market,” says Khalaf. “It is more difficult to gauge whether individuals are selecting stocks on the basis of ESG credentials, but the continued popularity of Shell and BP in portfolios suggests that any such activity is by no means universal.”

One thing everyone can agree on is that better access to ESG data will encourage investors to make sustainable choices.

Information Is Power When It Comes to ESG

IG Group’s experience is that demand from retail investors is primarily in the form of information with which they can make better informed decisions on their investments observes Adam Blemings, the firm’s Head of Trading, who divides ESG investing into two categories:

• Factoring company ESG credentials into the stock picking process

• Choosing an ESG, socially responsible investment or impact fund over its market cap equivalent

“One of the greatest challenges for making ESG-based investment decisions is getting access to – and interpreting – information or ratings,” he added. “For example, some of the ratings systems are sector specific so that the same rating given to a financial services firm doesn't mean the same as for a mining company if you were to compare the two companies head-to-head.”

Many retail investors are deterred from ESG investing due to higher fees and the need for more understanding of the rating criteria suggests Fleckten, who reckons retail interest will continue to grow in regions where new sustainability regulations are being mandated.

Matt Weller, Global Head of Research, StoneX Retail
Matt Weller, Global Head of Research, StoneX Retail

Swissquote has detected a clear preference among its customers for products that provide a tangible solution rather than just a ‘feel good’ ESG score according to spokesperson Nadja Keller. “Actively managed certificates such as ‘sustainable energy’ (which invests in companies positioned in renewables) or ‘decarbonisation’ – which invests in companies building products that reduce CO2 emissions – are in much higher demand than ‘social responsibility’, which is based on an ESG score,” she said.

FCA ‘Greenwashing’ Proposals Receive Cautious Welcome

In October, the FCA opened a consultation on proposals to introduce sustainable investment product labels, impose restrictions on how certain sustainability-related terms can be used in product names and marketing for products which don’t qualify for the sustainable investment labels, introduce consumer-facing disclosures to help consumers understand the key sustainability-related features of an investment product (including investments that a consumer may not expect to be held in the product), and require more detailed disclosure.

Keller believes the FCA's proposal to introduce investment product sustainability labels and restrictions on how terms like ESG, green or sustainable can be used will make it easier for customers to make investment decisions with an ESG focus. “We work with a number of specialist partners that evaluate company and sectoral data to provide relevant ESG information,” she said.

According to Fleckten, the proposed criteria set a high standard for financial products that make sustainability claims. “The FCA approach is different to some of the EU and US regulatory disclosure strategies that aim to categorise products to determine the type of disclosure requirements required,” she stated.

The proposed new sustainable labels should help ethical investors back their preferred investment approach and the greater regulatory hurdles to marketing a fund as sustainable should also force asset managers to start ‘walking the walk’ reckoned Khalaf.

“However, both the regulator and the industry face the immense challenge that sustainability characteristics are dynamic and complex and need to be squared with simple communications that allow investors to make informed choices,” he added. “Clearer labelling and disclosure will hopefully give us a better picture of how many truly sustainable funds are out there, as well as giving investors greater confidence in their ethical investment decisions.”

Interactive Investor welcomes the FCA’s intervention on the basis that there are many competing – and often conflicting ratings – systems and definitions and investors need to have trust in the labelling system. “The measures should also stamp out any scope for potential exaggerated claims or unintentionally misleading fund names,” said Jackson.

It is possible that the introduction of stricter standards and definitions for sustainable products leads to a decline in ESG assets, similar to what happened in the EU when the SFDR regulations were introduced suggested Johannesen.

“However, the rules are also about protecting the credibility of the industry and by separating the good from the bad, the end client should be better off,” she concluded.

The biblical phrase ‘There is nothing new under the sun’ is particularly appropriate when applied to investments based on environmental, social or governance (ESG) principles given that the origins of ethical investment can be traced back to the prohibition on investing in businesses with links to alcohol, tobacco or gambling exercised by religious groups such as the Quakers in the 19th century.

Fast forward to the 1960s and movements such as opposition to the apartheid regime in South Africa spawned the term ‘socially responsible investing’ with investors becoming more sophisticated about the sectors and stocks they wished to avoid.

The first proper discussion of how to integrate ESG into investment decision-making was prompted by the UN’s 2004 ‘Who Cares Wins’ initiative, which described ESG integration as an important source of competitive differentiation and value creation for financial institutions. But, almost two decades later, recent survey data suggests that many retail investors remain ambivalent when it comes to attitudes to ESG investment.

“Customer exposure to sustainable funds is slowly creeping up,” says Interactive Investor spokesperson, Jemma Jackson. “What is interesting is that even after the year to date – which has been torrid for the sustainable funds sector due to a large exposure to growth stocks – this trend has continued.”

Morningstar’s latest quarterly global sustainable fund flows report found that sustainable funds attracted $22.5 billion of new net money in the third quarter of 2022, which is down from $33.9 billion in Q2, and the number of fund launches was also down.

Jemma Jackson, Interactive Investor
Jemma Jackson, Interactive Investor

Of course, these figures should be considered in the context of investor concerns over the global economy, inflationary pressures, rising interest rates, and the conflict in Ukraine. In fact, assets in global sustainable funds were down just 1.6% between July and September compared to a 7.5% decline for the broader market.

However, a survey of DIY traders and investors published by Capital.com in September found that more than half had never selected a stock or made a trade based on ESG criteria with only 7% citing social and environmental reasons as their criteria for making an investment decision.

Investors Pursue a Variety of Strategies

“There is definitely some enthusiasm for ESG investing from retail investors,” says Laith Khalaf, the Head of Investment Analysis at AJ Bell. “There has been significant growth in ESG fund flows in recent years, but within the UK they still only account for around 6% of total fund assets – and that is using a fairly broad classification of ESG.”

Cecile Fleckten, the Head of ESG and Sustainability at Interactive Brokers refers to the demand for both tracking indexes and investing in specific stocks, while Saxo Bank’s Head of Commercial ESG, Ida Kassa Johannesen, says clients are increasingly interested in ESG ETFs.

“The general zeitgeist in favour of broad diversification at low cost applies to ESG investing as well, making indices the most popular way for retail traders to institute ESG principles into their portfolios,” says Matt Weller, the Global Head of Research at FOREX.com and City Index.

Investors who prefer picking individual stocks most commonly use ESG as a ‘negative screen’, meaning they intentionally avoid investing in the stocks with the worst ESG policies, rather than proactively investing in firms that are seen as particularly ESG-conscious.

“Both tracker funds and active funds have been popular ways to access this market,” says Khalaf. “It is more difficult to gauge whether individuals are selecting stocks on the basis of ESG credentials, but the continued popularity of Shell and BP in portfolios suggests that any such activity is by no means universal.”

One thing everyone can agree on is that better access to ESG data will encourage investors to make sustainable choices.

Information Is Power When It Comes to ESG

IG Group’s experience is that demand from retail investors is primarily in the form of information with which they can make better informed decisions on their investments observes Adam Blemings, the firm’s Head of Trading, who divides ESG investing into two categories:

• Factoring company ESG credentials into the stock picking process

• Choosing an ESG, socially responsible investment or impact fund over its market cap equivalent

“One of the greatest challenges for making ESG-based investment decisions is getting access to – and interpreting – information or ratings,” he added. “For example, some of the ratings systems are sector specific so that the same rating given to a financial services firm doesn't mean the same as for a mining company if you were to compare the two companies head-to-head.”

Many retail investors are deterred from ESG investing due to higher fees and the need for more understanding of the rating criteria suggests Fleckten, who reckons retail interest will continue to grow in regions where new sustainability regulations are being mandated.

Matt Weller, Global Head of Research, StoneX Retail
Matt Weller, Global Head of Research, StoneX Retail

Swissquote has detected a clear preference among its customers for products that provide a tangible solution rather than just a ‘feel good’ ESG score according to spokesperson Nadja Keller. “Actively managed certificates such as ‘sustainable energy’ (which invests in companies positioned in renewables) or ‘decarbonisation’ – which invests in companies building products that reduce CO2 emissions – are in much higher demand than ‘social responsibility’, which is based on an ESG score,” she said.

FCA ‘Greenwashing’ Proposals Receive Cautious Welcome

In October, the FCA opened a consultation on proposals to introduce sustainable investment product labels, impose restrictions on how certain sustainability-related terms can be used in product names and marketing for products which don’t qualify for the sustainable investment labels, introduce consumer-facing disclosures to help consumers understand the key sustainability-related features of an investment product (including investments that a consumer may not expect to be held in the product), and require more detailed disclosure.

Keller believes the FCA's proposal to introduce investment product sustainability labels and restrictions on how terms like ESG, green or sustainable can be used will make it easier for customers to make investment decisions with an ESG focus. “We work with a number of specialist partners that evaluate company and sectoral data to provide relevant ESG information,” she said.

According to Fleckten, the proposed criteria set a high standard for financial products that make sustainability claims. “The FCA approach is different to some of the EU and US regulatory disclosure strategies that aim to categorise products to determine the type of disclosure requirements required,” she stated.

The proposed new sustainable labels should help ethical investors back their preferred investment approach and the greater regulatory hurdles to marketing a fund as sustainable should also force asset managers to start ‘walking the walk’ reckoned Khalaf.

“However, both the regulator and the industry face the immense challenge that sustainability characteristics are dynamic and complex and need to be squared with simple communications that allow investors to make informed choices,” he added. “Clearer labelling and disclosure will hopefully give us a better picture of how many truly sustainable funds are out there, as well as giving investors greater confidence in their ethical investment decisions.”

Interactive Investor welcomes the FCA’s intervention on the basis that there are many competing – and often conflicting ratings – systems and definitions and investors need to have trust in the labelling system. “The measures should also stamp out any scope for potential exaggerated claims or unintentionally misleading fund names,” said Jackson.

It is possible that the introduction of stricter standards and definitions for sustainable products leads to a decline in ESG assets, similar to what happened in the EU when the SFDR regulations were introduced suggested Johannesen.

“However, the rules are also about protecting the credibility of the industry and by separating the good from the bad, the end client should be better off,” she concluded.

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