Date: October 2024
Author: Dean Wetton Advisory
The UK’s Evolving ESG Landscape: Change in Attitudes
In recent years, the UK has seen a significant shift towards embracing Environmental, Social and Governance (ESG) principles, driven by progressive policies and regulations. Its regulatory framework increasingly mandates that investment strategies consider ESG & Climate factors which in turn seems to have had the effect of shaping Trustee investment decisions in favour of positive integration of ESG & Climate factors. It would now be almost unheard of for an asset manager to not have an ESG policy.
DWA has been running a Master trust Universe Comparison since 2020 and has noticed an increasing recognition of ESG principles by every considered master trust, with the overwhelming majority having a least one fund component in their default which explicitly considers ESG factors. At present, the primary focus has been on Climate Change, with a general belief that Governance aspects are largely already integrated and that Social factors are harder to quantify and invest in. The introduction of TCFD reporting regulation further compounded this focus on climate factors.
Challenges in ESG Integration
While the UK has observed a relatively smooth adoption of ESG principles up till now, it has become a more controversial issue in the US, proving divisive politically and economically. Although the issue can sometimes be presented as “woke” vs “anti-woke” in practice, the US economy has a significant dependency on oil which has likely contributed to the US not seeing the same government push for increased ESG (and particularly climate change) adoption.
Many major US managers like BlackRock and JPMorgan have attempted to appeal to these competing demands by offering separate ESG and non-ESG mandates. While the goal is clearly to have a product for all clients, in practice this approach dilutes the impact of engagement efforts. If Blackrock is only supporting climate measures with a portion of their influence, it is difficult to believe that an issuer will take their expectations for change seriously, particularly for market capitalisation passive products.
The Future of ESG in the UK
There is a significant risk that the UK may import some of the controversies surrounding ESG and climate topics from the US, where they have become more polarising. Already, there is some discontent in the UK regarding net-zero commitments, with both cultural arguments and fears of an unjust transition pushing back.
It is in theory promising to see government plans to improve ESG rating practices, with UK Chancellor Rachel Reeves announcing a law to regulate ESG ratings providers in 2025, aiming to enhance transparency in sustainable finance and prevent greenwashing. In practice this may form the start of some government pushback against ESG, specifically to draw a clearer line between Social investing and Ethical investing.
The UK has a significant arms manufacturing sector which many ESG funds avoid. It would not be surprising to see the government push to have more ESG funds include these stocks to increase UK investment.
A case can be made for this. While ESG can be seen as an ethical belief, from a trustee perspective it should first and foremost be seen as an investment risk and opportunity consideration. Members primarily want their funds to grow, and while they may prefer (or even require) a net zero world and improved social practices in businesses Trustee’s must always be cognisant of not overstepping their remit.
Looking ahead, political factors will likely remain the driving force behind investment trends. Rather than focusing on what can be invested in, the more fruitful focus may well be effective engagement.
The benefit of the DWA’s ESG Rating System
ESG criteria help investors evaluate how companies manage risks and opportunities related to environmental, social and governance factors. While ESG is understood by many, the challenge lies in effectively incorporating these principles into investment strategies to align with beliefs and financial performance. Investors are increasingly becoming aware that ESG (and Climate) integration can be complicated, with even the individual components of E, S & G sometimes at odds with each other.
It has also become important to recognise that disinvestment is often insufficient to address ESG issues, and that in fact investment manager engagement is often a far more useful tool. In recognition of this, at DWA, we have updated our ESG Climate & Nature rating system to put a higher emphasis on engagement. Where our rating system differs from many other rating systems is that we focus on asset manager intention rather than specific holdings. Holding issuances from companies with poor ESG credentials can be acceptable if there is a clear path for engagement and improvement, potentially enhancing value and outcomes. We have scoring systems for all asset classes while recognising that engagement outside of Equity is more difficult.
Our rating system is a critical tool in assessing and comparing ESG performance and it aims to strike a balance between managing ESG Risks and Opportunities while maintaining competitive returns. While it offers a 1-10 score, 10 does not represent the “best” fund but rather the one most focused on targeting ESG, Climate or Nature-related issues. Typically, we expect the funds we recommend for a default to score between 4 and 6. These funds integrate ESG climate and nature issues to identify risks and opportunities to help improve investment performance, backed by a strong engagement policy.
How DWA Can Support Your ESG Investment Journey
Integrating ESG principles into your investment strategy requires a personalised approach. At DWA, we offer bespoke recommendations that align with your specific needs and values, focusing on genuine ESG integration while addressing greenwashing.
The DWA team is also experienced in climate reporting for investments, helping clients to produce TCFD reports as well as offering TCFD relevant training for Trustees and staff members.
For personalised investment solutions and to navigate the complexities of ESG integration, please email us on [email protected] or call +44 20 3422 5000 to schedule a consultation.