We're moving to Novia IQ
This is the last issue in which Sententia will appear in its current form and under its current name, but we will continue to post content in a new format. From January 2021, the mailer will take the form of a round-up of material recently posted to the Novia IQ site. So from the start of next year, Novia IQ will become your one-stop hub for technical and topical thought-leadership pieces from Novia Financial as well as Copia Capital Management, Novia Global and guests. We hope you continue to find this material interesting and useful.
The Green Agenda, ETFs and Government stimulus? by Robert Vaudry, Managing Director of Copia Capital Management
In a keynote speech last month, the Prime Minister, Boris Johnson, announced a 10-point Green Plan. In his usual lively manner, he described it as nothing short of a “self-styled green industrial revolution”. The speech was also an attempt by the Prime Minister to try and find common ground with President-elect Joe Biden, who had already begun to announce ambitious plans to tackle climate change, including a pledge to re-join the Paris Climate Agreement...
ESG and Sustainable Finance– Part 2 by Lee Coates OBE, Ethical Money and ESG Consultant
The observant amongst you will have noticed that the title of my two-part piece now includes Sustainable Finance. I have added Sustainable Finance to the title because it looks like the taxonomy from the EU and the FCA is moving in that direction. It also links in with the Government’s sustainable economy and society agenda. This is a fast-moving area, and the pace of change is increasing...
Optimising probability in retirement planning a thought piece from Just
Delivering a reliable income stream from a diversified portfolio over an unknown period of time has, rightly, been described by William Sharpe as “the nastiest, hardest problem in finance” and he should know. He created the "Sharpe Ratio" which looks to identify the performance of an investment against a risk-free asset, after adjusting it for risk as measured by standard deviation… rocket science in other words...
In a keynote speech last month, the Prime Minister, Boris Johnson, announced a 10-point Green Plan. In his usual lively manner, he described it as nothing short of a “self-styled green industrial revolution”.
The speech was also an attempt by the Prime Minister to try and find common ground with President-elect Joe Biden, who had already begun to announce ambitious plans to tackle climate change, including a pledge to re-join the Paris Climate Agreement.
The UK will Chair the COP26 meeting of world leaders on climate change in Glasgow in a year’s time, placing the Prime Minister at the heart of international attempts to build a consensus to curb global warming.
But whilst international bridge-building and co-operation is vital, it has its limitations, and it takes time.
Sometimes, if you want to get something done, you need to focus a little closer to home.
One of the points the Prime Minister made in his speech was a pledge to make London “the global centre of green finance”, but there was very little detail beyond this platitude.
Indeed, the next day the press mainly focused on the fact that many of the Green Plan’s pledges involved long-term financial commitments of funding and subsidies which the Treasury is going to find difficult to support until the extent of the cost of the Covid-19 crisis is better understood.
It will be quite a difficult balancing act, to promote a green agenda whilst somehow reigning in Government borrowing.
At the same time, as Lee Coates discusses below, regulators are moving towards making ESG part of the KYC process. We anticipate this will be in H1 next year.
This could prove a real inflection point for the take-up by investors of ESG funds.
To attract investors interested in ESG investing, thousands of companies have looked to re-assess their relationships with their customers, employees, suppliers, and the wider community – and this has undoubtedly helped their performance. It has also been good to see that, even at the height of the Covid-19 crisis, companies which scored highly against a set of ESG criteria performed well.
But whilst ESG funds’ performance has been strong over the last couple of years, often out-performing the broader indices, such out-performance is unlikely to be “sustainable”.
Various consultants have made good headway in identifying new ESG investment opportunities, but over the next couple of years we could see a tsunami of esoteric funds and fund managers emerge. Many of these will be very specialist and will not have been subject to detailed scrutiny.
Mistakes will be made, and consequently, investment performance could suffer.
There is a danger that the good will surrounding ESG investing could quickly evaporate if performance does deteriorate. If that happens, we could well see a slowing down – if not a reversal – in the number of corporates willing to change the way they operate.
I believe that investing in “green” ETFs could be one way around this problem.
A number are already liquid and well diversified. They are already highly scrutinised. They are transparent. Slowly adding esoteric funds into their universe will not put the ESG industry at risk but will still provide the opportunity for new managers to succeed.
But, given the Prime Minister’s speech, I think there is another option for the Government to explore.
If he really wants a green industrial revolution then the Prime Minister, and Rishi Sunak, should use all the resources government has at its disposal to stimulate one.
For Pension Funds, one way to achieve this is to make it, in effect, more tax efficient to invest in ESG funds than general market funds. Create a meaningful price differential between the two fund groups. Move the goalposts. Make it sustainable.
Of course, the stimulus will not apply forever, because in short order all funds will become ESG funds if the stimulus is working. The Government could really make a difference. London could really make a difference.
On Tuesday 26 January 2021, Copia and Novia are jointly hosting a webinar on ESG investing.
One of the speakers will be Guy Opperman MP, the Pensions Minister. Amongst a range of topics, I am keen to explore with him how he and Boris Johnson are going to make London “the global centre of green finance”.
Boris’ vision could yet become a reality. Let’s wait and see.
The observant amongst you will have noticed that the title of my two-part piece now includes Sustainable Finance. I have added Sustainable Finance to the title because it looks like the taxonomy from the EU and the FCA is moving in that direction. It also links in with the Government’s sustainable economy and society agenda. This is a fast-moving area, and the pace of change is increasing.
What is interesting is that ESG and Sustainable Finance are often used to describe the same thing but, in my opinion, the two are quite different in their application. ESG is more about the process, the metrics and Sustainable Finance is a direction, the outcome, a goal. For the purposes of this article, I am going to concentrate on the process and compliance – ESG.
In the earlier article, I made the comparison between your AML procedure and ESG – it is all in the process. It isn’t a question of developing a process if you encounter money laundering, you need to demonstrate you have a process in place to identify money laundering and take to action if necessary. ESG is just the same; you need something in place before you start to ask clients the question. Regulators are moving towards making ESG and Sustainable Finance part of the KYC process, so advisers are going to need to develop a process which meets the needs of their client base and their own business model. For ESG, advisers will need to have a 3-part process to be able to deliver advice in this area. These three parts form the core elements of your written ESG process. These parts are:
1) Fact Find – you will need to include a question on ESG or Sustainable Finance in the Fact Find process. It might just require a simple Yes/No answer from the client on the main Fact Find. If the answer is no, then that is it; your Fact Find has recorded that ESG is not for the client and your Reason Why Letter can confirm the client’s understanding and implication of their decision. If the answer is Yes, then you move to Part 2.
2) Information gathering and record keeping – I suggest that you have a separate ESG questionnaire to gather information on the client’s interests and preferences. Having it as a separate form (like a separate Attitude to Risk form) ensures the main Fact Find isn’t cluttered with extra information that may not be relevant to all clients. How the information is recorded and what use is made of the information, is dictated by your ESG Compliance process. Once a client has said Yes to ESG and you have gathered their views on environmental, social and governance issues, you can move to the final part of the process.
3) Compliance research and delivery – over time advisers will become familiar with the best managers and funds in the ESG space, but in the early days it is likely you will need to use a third-party service. Such a service will allow you to convert the information gathered from the client into a filtered list of acceptable investment opportunities. As with all good compliance procedures, it is all about recording information, documenting research, and explaining the results. The better the third-party service, the more comprehensive the results and the easier it will be for you to build this into your Suitability Letter. Some of the third party services, such as Ethical Screening () offer a free to use online database of ESG, ethical and Responsible funds for financial advisers. It would be worth registering for this service now, to familiarise yourself with what managers are offering, and you will receive updates as new funds are developed.
Although I have outlined three separate parts above, in reality they merge into a seamless and compliant process for delivering advice to clients interested in ESG. The support services I have described as part of (3) above can help you to deliver the final part. Based on my own research no one has thought about how advisers develop their own process, produce a workable ESG questionnaire with training support to explain and interpret the answers from client discussions and embed this into the firm’s compliance procedures – part (2). Help is, however, soon to arrive in the form of a new support service for financial advisers, Pension Scheme Trusts and Compliance Consultants - ESG Accord.
Working with a team of ESG and compliance professionals, ESG Accord has been developed to provide a support service for advisers to plug the compliance and support gap between client need and the fund research providers. We aim to deliver white label ESG questionnaires, pre-prepared ESG Compliance Manuals, Suitability Letter options and training on all aspects of ESG, responsible and sustainable money. The launch date for ESG Accord is slated for January 2021 so please look for further information via the normal Financial Services media as well as your Novia representative.
Delivering a reliable income stream from a diversified portfolio over an unknown period of time has, rightly, been described by William Sharpe as “the nastiest, hardest problem in finance” and he should know. He created the "Sharpe Ratio" which looks to identify the performance of an investment against a risk-free asset, after adjusting it for risk as measured by standard deviation… rocket science in other words!
And it’s a type of lower level rocket science, statistical analysis, that is at the heart of how advisers can try and deal with this nasty problem and give their clients greater confidence that their retirement plans will ultimately succeed. This is the basis for the Probability-driven advice approach, pioneered back in the 1990’s by one time engineer and US financial planner Bill Bengen. To properly understand Bill’s groundbreaking research, we need to be clear on what question he was trying to answer on behalf of his clients and for which types of clients. As far as the question, it was something along these lines…
"If I want to hold on to my accumulated portfolio and use it to sustain my lifestyle during retirement, how much can I withdraw without running out of money before I die?"
So in other words, Bill Bengen was looking to establish the cost of self-annuitisation for clients who would rather put their trust in the investment markets than pay a lump sum of capital to an insurance company in return for a guaranteed income for life.
This approach is referred to as Probability-driven, because at its heart you are trying to identify a probability or likelihood of a plan working, based on the stochastic modelling of an investment portfolio against a number of variables; the greater the probability of success the more likely it is that the plan will work and the less likely it is to fail, bearing in mind that a failed retirement plan is pretty likely to end up in some form of complaint. So you want to avoid failures!
All good so far?...
There are however, two aspects to this approach of self-insuring your longevity throughout your retirement that have a cost when it comes to accessing a good level of income in the earlier years of retirement, when you are probably most likely to want to enjoy it:
So it can be argued that the Probability-driven advice approach could deliver sub-optimal outcomes when it comes to the sustainability of a given level of income, especially when a retiree is looking to take a higher amount in the earlier stages of their retirement.
There are however, a couple of things you could consider doing if the above sounds unpalatable. You could avoid all this malarkey around statistical analysis altogether and just ‘hope for the best’… turning probability into possibility, but I hope you’ll agree that’s not a wise planning strategy. Alternatively, you could consider how the inclusion of guaranteed income for life provided by Secure Lifetime Income into a client's retirement portfolio can increase the starting level of sustainable income due to the valuable addition of mortality credits, compared to holding a similar amount of fixed income within that portfolio. Just take a look at Secure Lifetime Income available within the Novia platform SIPP, to find out more.