Daryl Roxburgh is President and Global Head of BITA Risk. The BITA Wealth application provides suitability profiling, portfolio and model ESG and risk management, and compliance monitoring for wealth managers. Here, he outlines four key areas of danger that firms should be aware of as they attempt to embed ESG factors into their investment processes.

Two comments from clients come to mind when I think about our approach to creating a solution for ESG investing - undoubtedly one of the biggest trends of our time. The first is, “Your system turns the Investment Policy Statement from a dead filed paper into a living document at the centre of the investment process.” The second is, “You give my client advisors freedom within a framework.”

As will be made clear, implementing mass customisation in ESG and impact investing is not easy. But it was the logical evolution of our applications, as well as being the right thing to do for the planet, clients and the wealth sector’s own interests. Staying relevant is crucial as the biggest intergenerational wealth transfer in history gets underway.

We interviewed clients and reviewed academic and industry literature, investment houses and activists on both sides of the Atlantic during our research and development into ESG investing. Here are some of the biggest traps we found to be lying in wait for wealth managers.

Trap 1: Taxonomy – not coming to a common understanding of what ESG means
ESG is specifically directed at Environmental, Social and Governance factors that measure how a company is run and performs its business. It is one form of sustainable investing, which also includes SRI (Socially Responsible Investing), product exclusion, impact and active investing. Often people will group these forms under one label with which they are familiar, such as “impact”.

There can be tens or hundreds of these factors, but usually significance is given to a smaller number of aggregate factors. So, to avoid trap one, make sure all parties understand what should be included in terms of preferences and controls.

Trap 2: Client preferences – allowing mandates to be either vague or over proscriptive 
For decades clients have expressed preferences with respect to product involvement – the so called “sin stocks”. ESG extends the capability to measure a company’s attributes far beyond its industry sector. The danger is that each client will have their own ESG preferences and given free rein may be overly proscriptive about what can be included in a portfolio.

Equally, they could be quite vague. Clients’ preferences may range from “I want a greener portfolio than the benchmark”, through to them having a view on multiple product exclusions, ESG and impact factors.

My advice would be to define which preferences your firm can accommodate in an ESG Management Policy, together with how these are captured and delivered through your investment process.

So, to avoid trap two, and to make the ESG investment process scalable and consistent, clients’ preferences should be treated as structured data within a framework, with clear documentation for the client on what these mean and how they will be applied. In addition, the impact on the investable universe of the client preferences should be made clear to the client.