“If we drive my car where the wild things are
We got a green limousine
Everyone’s a star, but they won’t get far
Without a green limousine”
— The Badloves, “Green Limousine”
As an advice professional, you work hard to ensure that you provide advice that’s in the best interest of your clients.
It’s true that one of the key aspects of a good advice process is establishing client objectives and identifying needs, but an often overlooked step is providing education where necessary and gauging client experience.
Providing appropriate advice, in accordance with the Standards, often means discussing matters beyond the initial subject matter of the advice being sought, as well as exploring client priorities, preferences, and trade-offs during these discussions. This ensures that all relevant areas are considered, and helps to more precisely determine what’s important to the client (and what’s not).
An adviser’s not an order-taker, so even if your client has a specific request or preference, your duty is to objectively consider these and whether implementing their request or preferences is in their best interests. As with all advice, simply acting on the client’s request is fraught with danger.
Recently, there has been a bit of a ‘boom’ in the ethical investment space and increasing client demand for Socially Responsible Investment. If you haven’t been asked to consider SRI yet, it may only be a matter of time.
Socially Responsible Investment
“What is it? (It’s it!)”
— Faith No More, “Epic”
- Ethical investing, also known as Socially Responsible Investing (SRI), is a strategy employed by a fund manager, or managers, which is based on the prioritisation of environmental, social and governance (ESG) outcomes. Human well-being and environmental factors are considered in depth and a higher prioritisation given to these areas then some of the other more traditional investment strategies.
The main factors which are associated with ethical investing are:
- Environmental (conservation):
- Energy usage; management of waste and pollution; natural resource impact; animal testing; compliance etc.
- Social (people):
- Slavery; equal opportunity; philanthropy; employee’s well-being; ethical practices etc.
- Governance (company management):
- Transparency; accountability; leadership team; conduct; political contributions etc.
There are also other factors to consider when strategising. One of the more common questions being asked is whether a negative or positive screening process is applied during investment selection.
- Negative: Companies that do not align with certain criteria are excluded.
- Positive: Companies that meet certain criteria are actively sought out.
To start, you need to understand more than the headlines, you need to both understand the client’s request and the product(s) which might be appropriate to be recommended.
Sound advice needs to demonstrate more than the adviser considering their client’s relevant circumstances; they also need to ensure that they are considering other concerns which may be just as important, if not more, as their client’s financial concerns (FASEA Standard 6).
This is occurring to some degree, but it’s not always managed effectively.
SRI-ous errors
The most common gaps we see within adviser files are:
Not uncovering the investment objective adequately
A box gets ticked within the risk profile or file note template, and then that’s about all that happens until the advice document. In some cases, an ‘ethical’ option is then included within the portfolio, but it is not entirely clear what the client wanted in the first place.
The first question that is usually not asked, is what ethical investing actually means to the client. It is also unclear whether any education was provided (if the client was unsure of anything) and the rest is made up of assumptions from the adviser. Uncovering the investment objective, but not addressing it adequately
Discussions occur, and the client is quite clear on what they want their investment approach to be, but the process does not get documented sufficiently through the file, or the portfolio partially addresses the client’s preferences.
This potential issue usually arises when there may be specific things the client wants to invest in. For example, the client(s) may have wanted to avoid certain things within their portfolio, such as firearms, tobacco, gambling, animal cruelty and slavery.
Alternatively, there may be some things the client specifically wanted to invest in, such as renewable energy, sustainable products, workplace equality and businesses with good safety records, but what can end up happening is that the research process does not adequately (or clearly) consider all of the client’s preferences. Alternatively, the explanations omit key aspects of the advice, and it cannot be determined whether the outcome (as a whole) has adequately addressed the client’s objectives.
This makes it difficult to confirm both the advice process is appropriate, along with the advice.
Not addressing the goal or need
All too often we see that an adviser has taken the time to uncover the client’s ethical investment objectives, but either ignored them, or forgot about them, during the construction of the advice.
This can sometimes come down to the adviser’s inability to know how to address it, or a discussion gets left out of a file note.
When it is the adviser’s choice not to address it, this is a concern. Ignoring it creates an outcome where the client’s objectives aren’t met, or if the adviser is executing on the advice without the required level of knowledge, then there is a potential failure of Best Interest Duty S961B(2)(d).
Thankfully, more often than not, it is a documentation issue, rather than a failure of BID.
During education and discussion of disadvantages, the client may decide that it isn’t as high a priority as originally thought.
It may also be due to the adviser’s research process identifying key risks which may not have been documented properly.
What to do about it
- Ask questions, provide education (where necessary) and ask for clarification.
- Research available products and compare them based on features, price, quality, performance history and other relevant factors.
- Critically consider the options available and evaluate based on client’s needs, objectives and preferences (with reference to advantages and disadvantages).
- Make the recommendation, explaining it clearly and check in during presentation to confirm that objectives have been met.
- As with any financial product, there are disadvantages and risks involved.
Ethical investing is nothing new, but it has certainly come a long way since it was introduced. After speaking with adviser’s, it is clear there are plenty of opportunities out there, but one thing that can be frustrating is obtaining the long-term information relating to performance. This can create some limitations in analysis and benchmarking in some cases.
Some things to look out for
There may be limited investment options. If a client is searching for certain criteria, this may significantly reduce the available options and there is a risk of having a lower level of diversification, or missing out on some growth, potentially limiting investment returns.
Ethical investing means different things to different people. There may be conflicting views on what needs to be done in order to qualify as an ‘ethical’ investment option, which can cause a mismatch in the outcome itself.
Volatility may also be a relevant factor to consider. Ethical investments are directly connected to, and reliant on, social, political and environmental issues which can be shifted quickly by policies, weather and public views.
And last, but certainly not least…Greenwashing.
Greenwashing
Greenwashing is a mash up of Green (environmentally friendly) and whitewashing (covering up) and is a technique applied by companies to make their products look more environmentally friendly than what they really are.
It’s designed to take advantage of consumer concerns and views on ethical and sustainable practices, and in itself is highly unethical (go figure). It is designed to boost sales and attract a higher number of investors – perhaps those who are environmentally conscious and would not have purchased products from, or invested in a particular company, otherwise.
This practice can range from misleading labelling to vague and false claims about environmental benefits, and all the way to fraudulent practices.
Admittedly, the Volkswagen story is not directly related to financial advice, but relevant to what we’re talking about.
In short, Volkswagen intentionally programmed their cars to activate their emissions controls during testing. In the real world, the levels of Nitrogen Oxides (specifically NOx) were up to 40 times higher than what was being registered during testing.
As always, the file needs to contain sufficient information to support the advice, and if the adviser feels that there are specific disadvantages, or risks in the approach being considered, then these are documented.
Ethical investing may be a hot topic, but based on what we have seen in the industry, more and more products are becoming available every day. As always, we’d ask advisers to follow the same rigorous process when constructing their advice in conducting a reasonable investigation into products, and assessing that information, prior to making any recommendations.
For those who are waiting for the fad to be over, it won’t be. If the case brought against REST is anything to go by, sustainable investing will be a whole lot more sustainable.
