Matthias Breier (pictured), head of ESG product at FE fundinfo
A considerable amount of recent publications has focused on the new regulatory framework for ESG funds in the UK, known as SDR.
The prevailing tone across these discussions has been overwhelmingly positive so far, a conclusion I generally agree with.
A crucial aspect of ESG revolves around bolstering investor trust.
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The establishment of clear guidelines that prevent misleading names and non-sustainable investments plays a pivotal role in achieving this.
Based on this premise, the new regulation presents two noteworthy aspects that frequently surface.
Firstly, it explicitly demands comprehensive information on how the sustainability objective may potentially clash with conflicting sustainability goals.
Secondly, it distinctly requires an explanation for investments that deviate from the established sustainability objective.
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These findings will provide intriguing insights into the strategies and motivations behind portfolio managers' choices when investing in specific companies.
Often, investors have been left with questions when trying to comprehend why certain companies appear on investment lists.
Conflicting sustainability objectives
Given the diversity in approaches to sustainability, it is only logical to anticipate that certain methods may have adverse effects on others.
For example, a fund might set its sustainability objective to invest in the development of new affordable real estate, providing first-time buyers with an accessible path to homeownership.
In pursuit of this goal, the fund finances companies dedicated to constructing new homes, aligning itself with a social sustainability objective.
However, it is essential to acknowledge the potential adverse effects on sustainability goals related to climate change prevention.
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The construction process may adopt more carbon-intensive practices to minimise resource usage, with the use of concrete itself contributing significantly to carbon emissions.
Examining a different example, financing wind turbines can be justified as contributing to a sustainability objective in terms of climate change mitigation, supporting the expansion of renewable energy sources.
However, it is important to acknowledge the potential drawbacks, as wind turbines are known to pose potential threats to birds, with unclear and potentially harmful effects on overall biodiversity.
This presents another instance of conflicting sustainability objectives.
Understanding these conflicts and the thoughts and investments behind a fund makes it easier to understand how a fund achieves its sustainability objective, but also to understand how it might harm other objectives.
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While measuring the absolute value towards the targeted objective is relatively straightforward, assessing the relative value, taking into account negative exposures, proves to be a more challenging task.
Hence, this serves as a notable example of the Financial Conduct Authority advocating for increased transparency.
This push aims to foster a deeper understanding of how investment strategies may not only align with specific sustainability objectives but also potentially impede other goals.
Understanding assets that are not aligned with sustainability objective
A significant trust issue within sustainable funds in recent years stemmed from a lack of clarity on what aligns with a sustainability objective, and what does not.
Stepping back, it is natural for not all investments within a fund to align fully with the same sustainability objective, or even with a sustainability objective at all.
Funds must have the flexibility to invest in specific assets to enhance diversification and mitigate risks.
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This should not be unexpected, emphasising that funds aim not only for sustainability but also ensure investments are diversified to secure long-term investor value.
However, this has often left investors surprised as they grapple with comprehending the rationale behind sustainable funds' investments in specific assets.
SDR adopts an intelligent approach, enhancing transparency in these investments.
The regulation mandates fund managers to elucidate the nature of assets that deviate from the sustainability objective and provide a rationale for these investments.
This information will provide additional insights into the assets incorporated into an investment product to enhance risk exposure and volatility, potentially influencing performance as well.
Increasing transparency and trust - how regulation can be beneficial
The sustainable finance industry experiences numerous fluctuations, often influenced by political factors.
What is crucial is recognising that regulators can reach agreements to enhance the transparency and trustworthiness of sustainable funds, a pivotal aspect in navigating the industry's dynamics.
The SDR regulation introduces unique and specific requirements, bringing forth new transparency and facilitating a better understanding of fund managers' investments.
It sheds light on how these investments may run counter to specific objectives.
For fund managers, this is an important topic, as they are now compelled to strategically consider these investments.
Matthias Breier is head of ESG product at FE fundinfo
