Wealth advisers risk failing investors on suitability by not using appropriate technology to measure environmental, social and governance (ESG) preferences and being caught up in the “green rush”, behavioural finance experts warn.
Oxford Risk, a fintech firm that provides behavioural finance-based solutions for asset managers, says technology should be used as a microscope to determine investors’ ESG preferences, but too often is acting as a blindfold with the risk that investors are not being matched to the right investments for them.
The firm is urging wealth advisers to make better use of technology to provide improved services to clients based on a solid understanding of their needs through detailed profiling.
Key problems it highlights include poor ESG labelling on funds which are becoming as “meaningless as the word ‘natural’ on a food label” and failing to record investors’ individual preferences which are often complex and contradictory.
It warns that a focus on what can be measured risks products being developed not to help investors meet their ESG goals, but to game the measurement system.
Research shows that most investors want the emotional comfort that ESG investments do what they claim to do and seek independent parties they can trust to verify those claims, Oxford Risk says, adding that the onus is on wealth advisers to match suitable ESG solutions to individual preferences.
Properly constructed ESG profiling benefits wealth managers by increasing the amount investors put in ESG investments by up to four times and making investors with high ESG preferences much more likely to invest overall.
Greg Davies, head of behavioural finance at Oxford Risk, says: “As the ESG industry expands, so does recognition of its darker elements. There are signs of trouble ahead. And it’s likely to be unsuspecting and unsatisfied investors left picking up the tab. Investor demand for investments with some sort of socially conscious edge is obviously rising. But it is in asking ‘what is it, exactly, that they want?’ that we start to see difficulties.”
Advisers need to determine how much ESG the investor should have, and then how much the investor is prepared to balance greater impact against financial returns. Advisers then need to select investments based on investor preferences, including considering their relative focus on E versus S versus G.
Oxford Risk says the best investment solution for each investor needs to be anchored on stable and accurate measures of risk tolerance. Behavioural profiling provides an opportunity for investors to learn about their own attitudes, emotions, and biases. This should be used to help investors control their emotions, not define the suitable risk of the portfolio itself, it adds.