How to personalise sustainable investment options for retail investors

Simon Smiles draws on standardised packaged food labels to help sustainable investments reach “its true potential” with retail investors

Sustainable investment is growing quickly, in terms of interest, adoption, and assets. However, different individuals like different things. And the current complexity, confusion and lack of ideal implementations is limiting take up of responsible and sustainable investment by retail investors. To reach its true potential, sustainable investing needs to personalise its approach for retail investors, focusing on the topics they most care about.

Retail investors’ interest is not currently matching their actual implementation. For example, a recent CFA report showed 69% of retail investors were interested in sustainable investment, yet only 10% have actually invested their money in this manner. There are at least three reasons for this material discrepancy.

1. Lack of simplicity

For money managers, the more/material/better quality data, the better. For retail investors, the more simplified and user-friendly data, the better.

For example, climate change is a growing concern amongst retail investors, but it is just one broad contributor to how environmental factors are currently measured by rating agencies. The OECD’s 2020 ESG Investing report found that there is a positive correlation between some ESG raters’ high E scores of corporate issuers and high levels of carbon emissions and waste, suggesting that aspects of the E score other than key environmental metrics, such as climate risk management and governance, have greater weights in the methodologies that determine scores.

As a result, the OECD explicitly recommends that “investors should take care not to misinterpret the information content of the E score as being aligned with low emissions, low-carbon portfolios or low-carbon transition.”

2. Lack of consistency

Contrary to corporate financial data that companies have to report in a particular, codified way, corporate sustainability data currently lacks such standardisation. And retail investors typically require simple, consistent facts and figures to find investment solutions that meet their financial and societal objectives.

There is a lack of consensus on how many and what aspects of E, S and G should be assessed in each relevant dimension, and as a result, different providers score ESG-related criteria differently. Researchers at MIT’s Sloan School of Management recently conducted a study of six top ESG ratings firms and concluded that “ratings from different providers disagree substantially….The correlations between the ratings are on average 0.54, and range from 0.38 to 0.71.

3. Lack of personalised implementations

Different retail investors have different sustainable investment area interests. Yet ratings currently used in most available products are aggregate measures. An ESG rating is a composite of its individual E, S and G scores, but there may be little correlation between the individual pillars. A company or fund may have a high environmental impact score but rate low on social impact, resulting in an average ESG score overall. And, as above, a high environmental score also does not necessarily even indicate a positive climate change score.

Solution: simple, consistent and personalised implementation

In traditional investing, retail investors typically look at a subset of price to earnings, dividend yield, leverage, and/or expected growth measures. Similarly, packaged food consumers are provided with standardised, consistent tables including calories, fat, carbohydrates, protein, and salt. Typically not all of these are considered by each consumer, but one or more are considered when comparing two similar food items. For example, a body builder might focus on protein, a person on a diet on calories and fat, and a person with heart disease on cholesterol and sodium.

A similar approach should be adopted in sustainable investment. Retail investors can focus on five to 10 standardised, understandable metrics that their investment capital impacts. And the ‘Key Sustainability Components’ table below could be shown for every investable company.

This will allow the easy development of a new range of credible sustainable investments that appeal to a much wider range of retail investors that utilise this simple, consistent and personalised data.

For example, mass ‘personalised’ advisory implementations covering bonds and equities, which combine each individual investor’s preferences across all 5-10 standardised, simplified measures.

Using the “Personal Preferences” table above and company scores shown earlier in the “Key Sustainability Components” table, can arrive at very different outcomes for different individuals, and to current aggregated ratings. Applying no weight in the personalised rating for measures indicated by the individual as a low preference/priority, 1x weight for medium priorities, and 2x weight for high priorities  suggests a company rated as neutral by current aggregated ESG ratings at 52nd percentile of all companies would in reality be attractive for person 1 (76th percentile of all companies) and unattractive for person 2 (only 29th percentile). This could also be applied to government debt.

Meanwhile, ETFs and mutual funds could consider including only companies in the top 25% of each sector on a particular measure. While certain thematic funds currently exist, provision of ‘Key Sustainability Components’ tables by all companies would provide a significant improvement in the simplicity, consistency and true personalisation of the investment instruments available for retail investors. The provision could also provide a significant improvement in the simplicity, consistency and true personalisation of the private equity thematic funds available for larger retail investors.

To reach its true potential, sustainable investing needs to personalise its approach for retail investors, focusing on the topics they most care about. As Barbara Novick, co-founder of BlackRock, has been quoted by Bloomberg as saying: “If you throw everything in one big bucket, nobody really knows what you’ve got.”

Simon Smiles retired from his role as Group Managing Director and CIO for Ultra High Net Worth Clients at UBS in 2020. He established and ran the wealth management sustainable and impact investing teams.