These tensions are not just apparent when it comes to an unexpected event such as war, but in traditional and relatively well understood businesses. Speaking to Which?, Util CEO Patrick Wood Uribe uses the example of a tobacco company with good labour relations and sustainable farming practices being likely to receive a good ESG score. This reflects that they are “good”, internally, and relatively in their field, but this can’t be equated with a moral judgment on the field that they’re in and the impact it has on the world, where smoking remains the primary cause of preventable and premature death in England, reducing quality of life and life expectancy.
Despite these seemingly irreconcilable positions, Uribe remains optimistic. “Where there is huge amount of demand and… unreliable supply then that's very often where you get these grey areas. In that equation what's really good is that there’s this huge amount of demand.”
Competing factors
This dynamic underlines why it is important for investors (and savers) to understand what counts as “ESG” and how it is weighted, and heats up as the market moves to meet the growing demand. During this period the onus on the asset management industry to help investors understand where they are putting their money increases. This may come through greater transparency, but alongside this, simplicity and clarity is needed if the industry wants to lose the description of “the only industry where you don’t know what you’re buying”. Whilst this description is not exclusive to ESG funds, where people have made a proactive and positive choice to invest in ESG funds or assets, there is a new, more personal feeling, level of scrutiny.
The Deloitte Financial Services Blog considers the accompanying lack of transparency in ESG ratings data which makes it hard for ratings users to understand the weighting of different factors as well as the completeness of factors used. Without this understanding, not only are investors and potential investors left without clarity, it is hard for companies to know how they can improve their scores. The blog points out that these difficulties may be exacerbated by the ability of ESG data providers to change their methodologies without consultation, making comparison over time, as well as between ratings, less possible. The FCA’s own data shows an increase in the number of poorly drafted ESG fund applications in the absence of strict definitions, meaning greenwashing and mis-selling risks continue to affect investors and savers.
And it’s not just individuals who need to balance these tensions. In a recent speech to the City UK International Conference the Bank of England’s Sarah Breeden noted the difficulty of managing the trade offswith regard to reaching net zero by 2050 for central banks, and the system as a whole. “Those trade offs are environmental and economic as well as political, social and distributional. Managing these effectively is like walking on a tightrope - we need to maintain the right balance.”
Young investor challenge
So how do we maintain the balance as the imperative to save and invest for a secure financial future increasingly falls to individuals, and they seek to match their portfolios to their convictions, is this becoming easier or harder? This challenge looks particularly acute for Gen Z.
Merryn Somerset-Webb described the younger generation as more engaged, more critical of capitalism and more tech savvy. Attributes which leave them poised to quite literally put their money where their mouth is when they start saving and investing, whether through auto enrollment or otherwise.
However, in 2021 the RSA described Gen Z as “generation precariat”. Their research found 56% of young people in work are financially precarious, as the proportion of 16 - 24 year olds in financial precarity increases with age from 38% at 16 - 18 to 57% of 22 - 24 year olds. Compared with the Financial Conduct Authority findings that over a quarter of UK adults have low financial resilience, the challenge for this generation is clear. This dynamic will be exacerbated as young people face bills rising faster than wages.
In these years people are more likely to use savings and accrue debt. Fifty one percent think they won’t be able to retire, due to what Fran Landreth-Strong, RSA Researcher and the report’s lead author called a “toxic cocktail” of factors, including inadequate work and safety nets, debt and cost of living. The cost of living crisis has since become more acute in 2022, so the challenge for young people is to make an investment return - can they afford to “do good” as well?
Better returns
For this to work, the “greenium” needs to be real, whether in investments through an eventual lower cost of capital, or a better savings return, though sustainable savings products have not progressed as much as investment options, aside from more specialist providers. The hoped lower cost of capital and therefore better long term for ESG focussed businesses is complex to assess and has yet to be proven, and may never be given the many moving parts to disentangle.
For Rebecca Self, Senior Advisor on Sustainable Finance at South Pole and Managing Director and Founder of Seawolf Sustainability Consulting, we still need to start with governance. “Governance underpins environmental and social considerations and factors. If governance isn’t right (sanctions compliance, anti-money laundering) then you can start to forget the rest.”
This includes the push from government and policy makers for more than the required actions, such as the recent Government support for “signals of intent” by businesses going beyond the legal and regulatory requirements and weighing up profitability with ESG values and culture and the cost of not meeting social standards or incurring reputational risk when it comes to matters like the war in Ukraine and the resultant Russian sanctions. This push is important as “for big changes the private sector won’t get there by itself” said Self. She further comments that such an approach is also likely to benefit business in the longer run as “the challenge of ESG is that it will always encompass dynamic issues which are more likely to be unprecedented”.
However in terms of the specific incentive to select ESG investments or savings, Self argues it’s hard to isolate this. When considering the “greenium” for those who have issued both green and standard bonds the additional management effort (marketing, awareness building, working with regulators and stakeholders) and possible timing impact of the green issuance is not always taken into account when reflecting the premium achieved. Regulation, geography and other macroeconomic variables can also have an impact.
This confluence of factors has created a situation where unless there is clarity and demonstrable value younger people in particular may face the choice of acting in (perhaps shorter term) self interest (another worthy “S” amidst a cost of living and long term saving crisis perhaps?) and making decisions which factor in ESG.