For investors who want to buy sustainable funds but worry about greenwashing there is good news this Isa season: it’s the first year they will be able to invest in products with a new official label.
Fund managers have a deadline of April 5 to decide whether to give their funds one of four new labels developed by the Financial Conduct Authority in response to concerns that retail investors might be buying supposedly sustainable products that weren’t doing what they said on the tin.
So far, at least 113 funds plan to use either an Improvers, Focus, Impact or Mixed Goals label, with others in the process of getting one. This will shrink the universe of sustainable funds, as many existing funds — Morningstar counted more than 400 last year — will need to stop using sustainable terms to describe themselves.
In Europe, 351 sustainable funds closed last year, while a further 115 dropped ESG-related terms, according to Morningstar, in part due to tighter regulations from both the EU and the UK.
The new pool of funds, while smaller, should be clearer. Funds with the new label must produce a simple two-page document for retail investors explaining what they do.
Professional investors hope the labels will help to sort those in the market that are serious about sustainable investing from those hopping on a bandwagon. Proving to the regulator that a fund deserves the label is an arduous task, fund managers say, involving a lot of paperwork.
“If someone’s got the label they’re serious about it,” argues Mike Appleby, one of the investment managers on the Liontrust team, which will give 10 of its existing funds the Sustainability Focus label in April.
Yet private investors should still check the top 10 holdings of a fund they’re considering to make sure it meets their personal preferences. The new labels should reduce surprises: it is easier to understand why an oil company might be in an Improver fund than in a bog standard ESG fund. Fund managers of Improver funds must engage with the companies they invest in to encourage them to take action, such as setting firmer emissions targets or disclosing more data. The companies they hold are therefore more likely to have room to improve.
Checking the top 10 holdings should also help investors find a Focus fund that is right for them, with a range of potential focus areas. Visa, for example, is the top overweight in Liontrust’s sustainable global growth fund. Appleby explains that it fits with a theme of security, with the payments company linked to the resilience of financial systems.
There can also be surprises in Impact funds. Language learning app Duolingo is a top 10 holding in Baillie Gifford’s Positive Change fund, for example. Impact funds are expected to invest in companies that have a specific and — crucially — measurable contribution to solving a problem with society or the environment, as well as the ability to generate a financial return.
Rosie Rankin, an investment specialist on the Positive Change fund, says Duolingo qualifies as it fits a theme of social inclusion and education: the app is popular in emerging markets, where language skills can increase job opportunities and in North America where immigrants use it to learn English.
Other sustainable funds are overweight in US tech companies, which may not appeal to all investors. The top four stocks in Axa’s Global Sustainable Managed fund, which will have an Improver label, are Apple, Alphabet, Amazon and Microsoft.
Any investor considering a sustainable Isa should also think about performance. The past five years have shown that sustainable funds can underperform the market on a short to medium-term basis, for example, due to their underweight in energy companies after the increase in prices following Russia’s invasion of Ukraine.
Sustainable funds can have a wide variety of portfolios, from growth to blue-chips, with the Liontrust and Baillie Gifford funds in the former category, for example.
Appleby argues that mid-cap growth companies are “massively undervalued” compared with the rest of the market. Rankin agrees that while growth stocks are expected to outperform, investors in the Positive Change fund should also expect volatility.
By contrast, the Jupiter Responsible Income fund, which will have an Improver label, has large-cap banks, insurers and healthcare stocks in the portfolio. Portfolio manager James Moir says that while sustainable approaches have often focused on high-growth companies that are leading the transition, investors more concerned about income and portfolio diversification can also invest sustainably.
Jane Wadia, a sustainability expert at Axa Investment Managers, argues that companies with sustainable practices will transition better and be around longer. “There will be quarters or years where that’s not the case; that’s something as an industry we have to accept,” she notes.
Ultimately, a sustainable label is a description rather than a badge of approval. A survey by the Investment Association last month found that 92 per cent of financial advisers reported an increased appetite for sustainable investment from investors. But return was still important, with 55 per cent of investors skewing towards weighting returns when asked to put it on a sliding scale next to sustainability and just 8 per cent skewing the other way.
Jake Moeller, a consultant at Square Mile Investment Consulting, which researches funds, says: “I hope that investors don’t start thinking of these labels as a proxy for quality. The labels are about the sustainability objectives, not about how skilful the fund manager is. Investors and advisers still have to do due diligence on the funds.”
https://www.ft.com/content/dd1d2e7d-7c7c-4968-a3bb-c330965bf18f
