The City watchdog said in late November 2021 that savers should not always be trusted to choose their own investments and proposed instead that pension firms offer one-size-fits-all portfolios that take into account climate change and other environmental, social and governance – or ESG – risks. Personal pension providers will specify a “green” fund as the default under the watchdog’s proposals.
However, existing “green” funds have been accused of being little more than a marketing trick as asset managers have flooded the market with poor-quality options for savers. Some supposedly ethical funds invest in oil companies and alcohol firms.
Despite these concerns, ESG funds have boomed in popularity. They accounted for 84% of investments into stock market funds in the past two years, a total of $15.1bn (£11.3bn) out of $18.1bn, according to Calastone, an analyst.
But investing ethically could hurt savers, analysts have warned. Fees are often significantly higher and the sheer amount of money flowing into so-called green stocks has pushed up valuations.
Tom McPhail of the Lang Cat, a pensions consultancy, said stockbrokers would use the new rules to push investors into expensive funds to boost their own profits. The Financial Conduct Authority, which has proposed the new rules, has not imposed any cap on costs.
Fund groups regularly charge more for ethical funds. Aviva, for example, charges 40% more for its £2bn “Stewardship” ethical mixed-asset workplace pension fund than for its regular version. It said costs were higher because it had to review the ethical principles of the firms it invested in.
However, there are fears that individual firms are overvalued. Morningstar, the analyst, said the 100 “most ethical” stocks in the FTSE All-Share index were three times more expensive, based on their earnings, than the market average. This is because ESG funds have tended to have more invested in fast-growing – but highly rated – technology stocks, which have lower carbon footprints than traditional oil and mining stocks.
Savita Subramanian of Bank of America warned that these “extreme inflows” might create a market bubble. The MSCI World ESG Leaders index has returned four percentage points more than the standard global index over five years, potentially leaving “green” investors at greater risk of a stock market crash or future poor performance.
Higher inflation has meant a crash is a more dangerous prospect as central banks raise interest rates sooner than expected. A higher Bank Rate increases the appeal of firms already returning cash to shareholders via dividends. Stocks labelled unethical, such as oil, tobacco and mining firms, would do well in this environment, while companies that promise profits in the distant future become less attractive.
Investors also face the danger of “greenwashing” – when funds claim to have climate, social or sustainable credentials that the underlying investments do not live up to. Tariq Fancy, who was fund giant BlackRock’s chief investment officer for sustainable finance until 2019, warned that ethical investing had “little to no impact” and said insiders had called it a “marketing gimmick”.
Part of the problem is that fund groups cannot decide on what constitutes an “ethical” investment: some own oil stocks and seek to influence them to be greener from within, while others exclude them from portfolios.
The ESG minefield of higher costs, dubious sustainability claims and inflated valuations means scrutiny of funds has never been more important. You can check what a fund owns by consulting its “factsheet”, available online, which will name the top 10 holdings and the sectors a fund invests in.
Savers will still be able to pick their own funds if they decline the default option proposed by the provider.
The FCA said more people were buying personal pensions without advice. Some took too much or too little risk, such as keeping everything in cash.
GSI has spent a good deal of time on ESG due diligence and has settled on a profile of four funds that are carefully monitored. Contact us for information on ESG investing in general and to find out more about our preferred solutions.
Adapted from an article by Sam Benstead in the Telegraph on 27 November 2021