Beyond ‘rainbow washing’: How investors are demanding real sustainable options

Consumers are increasingly making sustainable lifestyle choices, but when it comes down to the money, is this transition carrying over to their personal investment decisions? Kate Capocci, Associate Director and co-manager of the Tilney Sustainable funds, assesses changing investment trends in sustainability and investor behaviour.

The upward curve

Awareness among consumers about sustainable investments has soared in recent years. Environmental, governance and social (ESG) issues are of growing concern, especially as wealth is transferring to younger generations.

In the US, the Morgan Stanley Institute for Sustainable Investing report “Sustainable Signals - The Individual Investor Perspective (2021)” reveals that among wealthy individual investors (those with investable assets of at least $100,000), nearly four-fifths of participants were either very interested or somewhat interested in sustainable investing.[1] When solely looking at millennials, the figure jumps to 99%. In the UK, a survey conducted by Tilney through YouGov in 2021 showed 65% of respondents said they were more likely to invest in ESG in the next five years.[2]

A sustainable rate of return

Up until the end of 2021, sustainable investments saw a period of very strong growth, outperforming the wider market. 

However, through Q1 2022, higher interest rates and a jump in inflation (which was already a trend before the Russian invasion of Ukraine exacerbated energy costs) have led to a rotation to value stocks such as energy and banks. These kinds of ‘old economy’ stocks tend not to be held widely in more sustainability focused investment portfolios.

Overall, the consumer market in sustainable investments continues to grow, despite recent underperformance.

“Rainbow washing” and research

Non-professional investors must do their research if they want to ensure they are investing in sustainability and not just clever marketing. “Rainbow washing” is a phenomenon where companies market their sustainable credentials or highlight the UN Sustainable Development Goals they support without any proof about how they are working to achieve them.

It’s important to look at how meaningful those claims are. A company can claim they are researching climate-mitigation technologies, but if in reality that only represents 0.5% of their Research & Development budget, the claim is a little exaggerated.

At Tilney, Smith and Williamson, we invest often in funds, where we have no control over the underlying companies the funds are invested in. Therefore, it’s important for us to understand how sustainability influences a fund’s investment process, how they measure sustainability and how they practice stewardship. Meeting with the manager to fully understand their investment style and philosophy, and to question them on their underlying holdings is essential.

We do a huge amount of due diligence before making any new investment, but it remains difficult for consumers to carry out due diligence to the same degree.

Climate risk, COP26 and nature-related impacts

Climate risk is potentially the biggest risk markets have ever faced. Understanding climate risk, even if only at a high-level, is very important to protect long-term investments. This is a quickly developing area, so overall understanding is currently relatively poor. Climate change represents a global systemic risk, but one where the implications are little understood and the timing of these are entirely unknown.

A lot of investing is looking at different scenarios and climate is one of those. The Bank of England [3] has designed several different scenarios that represent different risks, but what investors lack is consistent quality data to help us model for different scenarios.

Aside from climate risk, sustainable regulations, both financial and non-financial, are increasing, and public understanding and concern on these issues are continuing to grow. Biodiversity presents an almost equally existential threat as climate, but it’s a tricker concept to evaluate, and impact on biodiversity is harder to effectively measure than GHG emissions. We are seeing some movement towards this aspect of sustainability from consumers.

Hopefully, the Task Force on Nature-related Financial Disclosures (TNFD) will eventually have the same impact as the Taskforce on Climate-related Financial Disclosures (TCFD). [4]

Wider, standardised reporting in this area is essential if we are even to begin assessing companies’ impacts on biodiversity and for governments to begin regulating.

Casting out the jargon

The jargon around sustainable investing remains confusing. This is not just for private investors, but for some investment managers too. A myriad of terms exist that are often used interchangeably. Terms are also defined differently among investment houses, making it difficult to identify investments that match their sustainable value.

First and foremost, it’s on the industry to be more transparent about what a product is doing and how we are investing. There are also important initiatives, such as the EU taxonomy, which are attempting to standardise definitions around sustainability. This is something that the UK’s Financial Conduct Authority could potentially choose to follow suit on. Initiatives like the EU taxonomy could improve standardisation and transparency - but UK-based investors need an equivalent, otherwise the scope remains limited to EU investments.

The main thing investors need to invest more sustainably is information. A huge step in this direction is being taken in April 2022 in the UK. It will become the first G20 country to make the TCFD reporting mandatory for large companies that meet the required threshold. This is applicable to over 1,300 of the largest UK-registered companies and financial institutions.

For Tilney, Smith & Williamson, signing up to the TCFD in 2021 enabled us to highlight our ongoing commitment to sustainability and climate action.  By so doing, we also led the way when engaging with our underlying investments, asking them to improve their carbon reporting.

Private investors can make a difference

Considering sustainability builds a broader picture of the long-term viability of an investment and highlights additional opportunities, and sometimes risks, that are material to the company in question. 

From a consumer perspective, the reasons for opting for sustainable funds can differ. A very pragmatic investor wants to consider sustainability factors to improve the rate of return. They recognise that this is the direction of travel and are trying to get ahead of it.

Other individuals prefer to ensure their investments do not negatively impact the environment or people. They are more likely to accept periods of underperformance, compared to markets generally, provided their money is not funding activities they don’t agree with.

With more individuals choosing sustainable investments, companies have to improve their practices in order to compete and continue to perform well in the stock market. There has been a significant shift in companies committing to net zero, including some energy companies, and investors continuing to scrutinise sustainability performance will ratchet up these efforts. Our investments can change the world.

[1] https://www.morganstanley.com/press-releases/sustainable-signals

[2] https://smithandwilliamson.com/en/campaigns/esg-report/

[3] https://www.bankofengland.co.uk/stress-testing

[4] https://tnfd.global/