Late last month the FMA released a review of 14 KiwiSaver and other managed funds, benchmarked against ESG (environmental, social and governance) investment guidance the regulator issued back in December 2020. The guidance included the type of framework the FMA expects managers to use to substantiate on reasonable grounds the claims they’re making about the credentials of their funds. As part of the review, the FMA surveyed 2500 people, using keywords the funds themselves used in the names or descriptions. It found that while 68% of respondents said they wanted ethical and responsible investments, few were actually buying into these funds. Of that 68%, only 26% had chosen a fund manager based on its ethical credentials.

The FMA concedes part of the problem is investor inertia. Most investors don’t read formal product disclosure statements and instead rely on fund managers’ websites and marketing materials and the opinions of their friends. But the industry is also at fault. The FMA wants disclosure statements to be more clearly and crisply written and in plain English so investors can make informed decisions.

“Investors were overwhelmed by technical jargon and often relied on a leap in faith in choosing an ethical investment,” says Paul Gregory, the FMA’s director of investment management. Others abandoned the search because it was “too hard”. “The simpler it is, the easier it is to understand and for investors to substantiate,” Gregory says. “It’s up to fund managers to have their own processes. They just need to explain it well and prove it. They just can’t pretend to be impressive and lie about it.”

He says managers need to do a better job on both product disclosure and ensuring their websites, marketing and advertising materials “knit together” so investors can be confident that products are delivering what they promise. Clear, effective and cohesive communications are what’s needed and as far as the FMA is concerned, websites, marketing and advertising collateral are all part of the disclosure regime. Gregory says investors tend to look at all this material, so it needs to form a clear overall picture.

The survey also found that descriptions of a fund’s non[1]financial benefits or objectives are sometimes so high-level that they are useless. And funds did not give investors enough information on performance measurement, reporting and the consequences of breaches.

Greenwashing

As demand for these funds increases, the FMA says it wants to ensure investors can be confident that products are delivering what they promise and that investors are protected from false and misleading claims. It is the overall impression that counts and omissions can be as misleading as false statements, it says.

‘Greenwashing’ – the making of false or misleading claims about a fund or product’s ethical credentials – is a breach of the Financial Markets Conduct Act 2013. The FMA can make stop orders to ban advertising or other disclosures that confuse, or are likely to confuse, investors on matters that influence their investment decisions. The penalty for failing to comply is a fine of up to $300,000. Samantha Barrass, the FMA’s chief executive, told the market back in March that the regulator would be targeting greenwashing as a priority this year.

Gregory says while the primary aim of the recent review was to check the industry’s uptake of the December 2020 guidance, it was also looking for evidence of greenwashing. “We didn’t find anything misleading but we did find lots of imprecision, lots of vagueness, lots of things that were too high-level to determine what they meant, let alone what would substantiate them,” he says.

“The reality is that there aren’t any defined standards as to what ‘ethical’ and ‘responsible’ mean and the regulator is the last person who should do that. So, if [fund managers] are doing that, [they] need to be very clear what [they] mean.” In other words, it is up to individual managers to define ‘ethical’ and ‘responsible’ and then do the downstream work of determining risk and impact.

“You can understand why fund managers might not want to trip themselves up with too much detail but unfortunately this isn’t about ethics,” Gregory says. “It’s about values and it has been shown in this market and others that while [some] people aren’t prepared to pay more for that type of product, in other cases, the [ESG] impact is more important than a financial return.

“So, if these are the choices being made by investors, then that better be what’s happening.” Fund managers making ESG claims can expect additional scrutiny from now on. “We’re done signalling, basically,” Gregory says. “We’ve said, ‘this is our view, this is the guidance and this is what we expect’. We’ve shown there’s a lot of work to do on disclosure, we’ve shown in the other research why the investor perspective matters. “And if you think about what’s coming by way of climate disclosure where it’s compulsory for some fund managers to report on this stuff, the direction of travel, plus the work we’ve done to date – it all points to doing a better job of this pretty quick.

“We’d expect to get a few complaints and that would be from investors or fund managers dobbing each other in because that’s what they do, so we’ll have plenty to go on, I suspect.”

Mandatory standards

But Barry Coates, founder and CEO of the Mindful Money charity, wants the FMA to go further. He says it should be setting and enforcing mandatory standards for ethical investing in the same way that the External Reporting Board (XRB) is doing for climate change. A clear set of standards would enable comparisons to be made between funds.

Coates says the XRB has been asked to do the groundwork on this after completing its climate change project, but these standards will be only voluntary. He thinks this is a mistake and wants compulsory standards as the audience for financial information is potential investors who are not necessarily experts.

Mindful Money did its own ethical investment survey back in April, in conjunction with the RIAA (Responsible Investment Association of Australasia). This found that despite concerns about greenwashing, nearly three-quarters of respondents (73%) wanted their funds to be invested responsibly and ethically, and 56% said they would consider switching KiwiSaver funds if they discovered their fund was investing in companies that were not consistent with their values.

The survey also points to what Mindful Money calls a “crucial” link between ethical investment and savings. If people knew their savings would make a positive difference, 53% said they would be motivated to save more. About two-thirds of those who do not already have an ethical or responsible fund said they are looking to invest in such a fund in the future. Demand is particularly strong among women (80%) and younger generations (71%) compared with only 63% of men.

The researchers say this support comes from a range of income groups, including those on low incomes and with low KiwiSaver balances. “Investing ethically is an issue for all, not just those with high levels of discretionary investment.” For many of those surveyed, it appears investors are not simply looking for funds that do well but investments that also do good. For 62%, it is important that their investments make a positive difference in the world.

Independent certification

More than 50% of Mindful Money’s respondents were concerned about greenwashing and 54% would be more likely to invest in a fund that was certified by an independent third party. Gregory likes this idea, so long as the basis for the certification is clear. He notes some managers have funds certified by RIAA where the criteria can be clearly visible and the process is “reasonably robust”.

“But again, on the transparency and disclosure part, [there is a] need to disclose exactly what that certification looked at. How tough was it? Or was it just a rubber stamp?” Coates thinks it’s important that the RIAA provides product certification but says it’s not a substitute for good public information.

“In the same way as you’ll want to know the data from financial returns from the funds you might invest in, we need information on the social and environmental impacts. Certification is not a displacement for that. It’s useful but we need the proper disclosure and reporting for the public.”

Around the industry, Coates says he is hearing lots of anxiety about the compliance burden. And because managers will need to provide evidence for their ESG claims, there are worries about the volumes of paperwork that will ensue – and that investors will be even more reluctant to read it. “I think that’s a valid concern which is why we’d like to see some clear reporting standards because once you get them, it becomes comparable across some funds. There is a risk of ending up with mountains of paperwork and no way of comparing funds.”

Chapman Tripp agrees. “The fundamental problem is the absence of agreed terms and definitions,” it says on its website, “and the temptation this creates to resort to puffery in order to avoid potential legal liability. To its credit, the industry is working actively and collectively to address this through the development of clear taxonomies and certification programs.”

It has five key tips for managers who want to stay on the right side of the law with their ESG funds:

•  Explain exclusions. Set out why the fund has excluded particular companies and sectors, and how exclusions will be applied in the future;
• Be clear about the relevance and weight of financial and non-financial factors in decision-making and the risks that come from including non-financial factors;
• Set out how you will select investments for your ESG funds;
•  Don’t rely in ‘high-level’ and amorphous claims of non-financial benefits and impacts; and
•   Explain how you will measure performance and deal with investments that no longer meet the original criteria for selection into ESG funds

Dedicated reports

While most managers are a long way from meeting the FMA’s expectations for ESG funds, two firms – Harbour Asset Management and Pathfinder – have produced dedicated sustainability reports. Pathfinder was first off the mark last year, describing its sustainability report as “transparent and meaningful disclosures” that would explain how the business is tracking towards its sustainability and returns goals. And, as CEO John Berry puts it, Pathfinder had been investing ethically “since before it was cool”.

Harbour’s managing director Andrew Bascand says his firm’s first annual sustainability report, released recently, was in response to increased investor demand that their fund managers pay attention to non-financial risks and focus on ESG aspects. He says Harbour will publish and report openly each year as the firm develops its approach to sustainable investing. “Both our local fixed income and equities investment processes consider ESG matters, alongside the case for generating investment returns.”

As its main tool for monitoring and assessing ESG concerns, Harbour uses a corporate behaviour survey tool, developed by the firm in 2009. Among other issues, the tool monitors responses to climate change, diversity, inequality and wellness.

“There is no end in sight to developing meaningful insight on sustainable investing,” Bascand says. He also notes that good governance often correlates with responsible investing. ■