Investment

Most family offices know ESG investing is a mess but will new global standards persuade them otherwise?

Family offices have been reluctant to invest in ESG funds for years, as reported in Family Capital last July. A new survey by Create Research shows they made the right decision.

The survey, sponsored by KPMG, has surveyed institutions managing a total of $34.5 trillion. And 79% of them say the very data supposed to underpin ESG funds is being fouled up by a lack of common definitions and climate standards.

A single, global, accounting standard, incorporating climate issues, has been slow to emerge. We are lacking an accurate price for carbon

They say companies are not required to report climate risks, and find it hard to calculate their exposures This means disclosure is voluntary and inconsistent. The repurposing of old funds into ESG strategies has produced greenwash, say 50% of Create’s respondents.

ESG funds have only managed to outperform in recent years for reasons their sponsors never considered – due to being heavily weighted to the technology sector. 

One baffled investor asked Create: “When people talk about factoring in ESG, what exactly are they talking about?”

It gets worse. Research by French consultant Edhec published on 21 September found 41% of companies owned by a sample of ETFs were suffering a deterioration in environmental metrics or higher carbon intensity.

Edhec says no more 12% of ESG weightings are driven by climate with the rest based on market values. Regulators have criticised ESG funds due to a lack of transparency or over-reliance on cap-weighted factors. 

Create says a plethora of ESG providers are using different models: “Inconsistencies have been common.” Judgements tend to be subjective. The frameworks used by the Sustainability Accounting Standards Board and Global Reporting Initiative vary in scope and emphasis. Across the ESG sector, every firm relies on its own ideas to earn fees, and few are willing to compromise for the common good.

The CFA Institute unveiled global standards for ESG on 1 November, in time for the Cop 26 climate summit in Glasgow. A pity we didn’t get it, years ago. 

A single, global, accounting standard, incorporating climate issues, has been slow to emerge. We are lacking an accurate price for carbon.

Climate lobbyist Duncan Austin believes markets take their cue from GDP and profit data, produced without taking a climate hit. 

The importance of this was understood a hundred years ago by British economist Arthur Pigou who said GDP data needed to be adjusted to take account of externalities. 

Economist Partha Dasgupta repeated the view this year pointing to a doubling of production per head between 1992 and 2014 and a 40% fall per head for natural capital. 

Profits are left unscathed. Directors remuneration takes some account of ESG, but the link is weak compared to share price growth and profits.

Alan Schwartz – co-head of family office Trawalla Group and lobby group Universal Commons – says impact investors are handicapped because accounting does not let them generate holistic returns from their actions, while mainstream companies enjoy a free ride.

However, the Create survey suggests 92% of respondents will be revamping their portfolios to take account of climate change over the next three years.  Big changes could be on the way.

Given the limitations of ESG, for example, judgements on the quality of corporate stewardship will grow, leading to activism. There will also be a focus on the ability of asset managers to drive this process, according to 81% of Create’s respondents.

Direct investing and venture capital has already taken family offices to climate-friendly sectors like fusion energy, electric cars, hydrogen, carbon-free cement and plant-based food. Others will follow. 

A family office survey by Julius Baer has found their interest in sustainability and private assets has risen more dramatically over five years than anything else.

Younger entrepreneurs and next gen have also been setting up their own family offices with a pronounced tilt towards climate solutions. 

Family offices could be joined by a new wall of money. Around 60% of Create’s respondents expect capital to flood into “blended finance” where governments and private investors join forces to deal with the big issues. 

Thought leader Roger Urwin of Willis Towers Watson says the world needs “universal owners” prepared to take meticulous care of their assets, and the externalities they throw up. 

But 71% of Create’s respondents say the capital markets put short-term profits over the importance of long-term value creation, while 67% say investors are poor at pricing negative outcomes.

Many respondents agree the challenge is best tackled by taking the effort to own private assets, where investors can get to grips with what they own, rather than investing in stocks and short-termism.

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