Giving people lots of options to choose from may sound like a good way to allow them to select exactly what they want and what makes them happiest, but the opposite can be the case. Studies have shown that an abundance of choice can lead to confusion and misery. This is known as the tyranny of choice and US psychologist Barry Schwartz has argued that when there are too many things to choose from, “people become weighed down by the pressure to make themselves happy”.
The problem can boil down to a lack of clarity. Labels that may appear blindingly obvious to their creators might be quite opaque to anyone else. This applies to the responsible investing arena as much as it does to any other walk of life: products come in a broad range of flavours including ethical, socially responsible, green and impact. But what do these labels actually mean and how can investors choose between them?
“ESG [environmental, social and governance], green, social and impact are probably the most common products,” says Deirdre Timmons, sustainable finance lead, ESG reporting and assurance, with PwC Ireland. “ESG focuses on measuring and managing environmental, social and governance risks and opportunities; green focuses on environmental themes; while social funds focus on themes that could relate to wider societal issues or corporate issues such as diversity and inclusion. Impact funds are intended to provide a positive impact through their investment activities – and that could be environmental, social or both.”
There are variations within each category. “Within those categories there will be many different types of funds with varying degrees of investment risk attached to them, so it is important that an investor does not just pick an impact fund simply because they would like to make an impact with their investment,” says Timmons.
“They need to understand how the fund is being managed, because aligning with their values may not always directly align with their risk appetite and their requirement for returns. An impact fund may be concentrated in a small amount of stocks, for example, and therefore the risk of that fund may be higher and may not be suitable for the financial needs of that investor.”
Timmons accepts that the multiplicity of labels can lead to some confusion. “The investment product developers decide on the labels and they must work within certain parameters under current EU regulation,” she says. “But it can still be very confusing for retail investors to understand what is in their funds.”
This has not gone unnoticed at the regulatory level.
“There are attempts to help this situation within the EU, with recent proposals for a categorisation system which would categorise funds as ‘sustainable’ – funds that invest in assets that are sustainable and do not cause harm, ‘transition’ – assets that are becoming more sustainable, ‘ESG collection’ – assets that either are not harmful or assets with better E, S or G credentials,” Timmons notes. “But retail investors should seek advice from a suitably qualified financial adviser if they are unsure of what they are investing in.”
Beyond understanding what a particular fund is invested in, there is the not so small matter of the potential returns on offer and the risks that come with them. According to Cantor Fitzgerald director of investment services Ian Halstead, numerous studies have demonstrated that ESG investing has tended to outperform its non-ESG counterpart in recent years. Indeed, a meta-analysis of more than 200 studies revealed outperformance in the past two to five years.
However, Halstead points out that the level of outperformance is not statistically significant and ESG investing shouldn’t necessarily be seen as a driver of superior returns.
The question for investors, however, is what type of returns they can expect, or hope for, from the specific type or types of investment they have chosen. They also need to be aware of the risks involved. For example, sustainable investment portfolios, regardless of the labels used, usually prioritise newer stocks in the small to medium cap range. These tend to offer greater growth potential and therefore higher returns over the longer term but increased volatility in the shorter term. Furthermore, there is the heightened risk of smaller, early-stage companies going out of business.
Ultimately, the best advice is to get professional guidance.
