What are robo-advisers bringing to the ethical investment party?

Written by Rebecca Jones on 22nd Nov 2018

The global popularity of so-called ‘robo’ advisers has mushroomed in recent years; with the amount of money managed by these online platforms surging 185 per cent from £109 billion in 2016 to £310 billion this year.[1]

Traditionally the preserve of those with mega portfolios, robo-advisers claim to bring wealth management to the masses – allowing anyone to invest in a risk targeted portfolio for – in some cases ­– as little as £1.

As such, robo-advisers have proved popular with many that could otherwise not afford financial advice, as well as with the so-called millennial generation that – according to a recent survey by BlackRock – much prefer to manage their money online. (Perhaps unsurprisingly, the generation that came of age during the financial crisis says it’s a little wary of financial institutions.)

Indeed, with jazzy, user friendly websites often picturing tattooed Mac users sipping flat whites in rustic cafes, it seems robo-advisers are increasingly aiming to appeal to a younger audience; the type that perhaps wants to invest through an app while waiting for a spin class (full disclosure: this is me).

However, as numerous other surveys have shown, millennials are more concerned about ensuring their money does good than previous generations, with most unwilling to invest in areas like tobacco and arms; and this is where robo-advisers – which tend to offer passive portfolios full of mainstream market trackers – have historically fallen down.

ESG for the masses

This may, then, explain why robo-advisers are now boosting their ESG – or environmental, social and governance – offerings, significantly.

This week saw one of the UK’s biggest robo-advisers, Nutmeg launch a range of ten ESG scored ‘socially responsible’ portfolios; a project the firm says has been a long-time in the making and involved extensive surveying of customers.

This follows hot on the heels of a launch by Wealthify, which in August released a selection of five risk targeted ethical portfolios, as well as online adviser Moola, which launched its ethical option earlier in March.

Meanwhile, Canadian contender Wealthsimple is launching into the UK market leading with its ready-made socially responsible portfolio – the first to be offered by any robo-adviser – which also claims to be cheaper than other contenders.

All of this activity is – without a shadow of a doubt – Good news.

Raechel Kelly, Senior Researcher and Communications Manager at Ethical Screening, comments:

“I think this is the beginning of a very exciting growth period in the SRI industry, these platforms are disrupting old business models and can adapt much more reflexively to fintech advances and social trends.

“With many platforms having low minimum investments and fees, there is huge potential to attract people to invest who may not have previously thought it was an option for them and this democratisation of the industry is also exciting.”

Good or greenwash?

Tempering her praise, however, Kelly adds that it is important to understand what portfolios like those offered by robo-advisers do and do not do.

Just like their mainstream offerings, these ethical portfolios are baskets of cheap, passive funds – mostly Exchange Traded Funds (ETFs) that are invested based on exclusions (or negative screens) that simply track markets.

What was once called ethical investing has, arguably, now been relabelled ESG and runs on an algorithm that also factors in corporate governance principles that focus on the environmental and social policies a company has in place.

The Nutmeg portfolios, for example, use ESG criteria set by global benchmark aggregator MSCI, and invest using ETFs tracking main markets. As a baseline, the process screens out tobacco and controversial weapons, with all other industries – including oil, gas and mining – up for inclusion.

The process aims to exclude the worst of the worst and instead include ‘best in-class’ firms. This means BP, Exxon Mobil or Rio Tinto will get in, for example, if they have some good practices embedded somewhere in the business.

As Beau O’Sullivan of UK activist investor network ShareAction states, while this is a nod in the right direction, it may not satisfy more conscientious younger investors:

“I pat all these providers on the back for their efforts. It’s a great start to attract younger investors. But while I have no doubt robo-adviser platforms are intricately finessed and fancy, buyer beware: their ESG stock picking process might not have undergone the same level of care.

He adds: “What’s the point of screening out weapons when the rest of the companies in the index are anything but good, for example?”

Exclusion vs. outcome

Not all of the providers listed above have exactly the same process. While Wealthsimple and Moola’s are pretty similar – both also using ETFs based on MSCI ESG criteria – Wealthify also includes some active funds, many of which are run by highly experienced human fund managers that carefully select and monitor investments.

Fundamentally, however, it is important to state that robo-adviser portfolios are not sustainable or impact investment funds.

Admittedly – and as Nutmeg points out in its recent literature – there are many funds that employ ‘sustainable’ or ‘impact’ in their fund titles that are doing little more than passive, ethically based strategies do; however the approaches are quite different conceptually.

In a nutshell, ethical and ESG strategies typically invest based on exclusions, while sustainable and impact funds invest based on outcomes.

These outcomes might be a reduction in Co2 emissions by investing in renewable energy suppliers, or decreasing road traffic deaths by investing in manufacturers of leading safety equipment, for example.

This means that sustainable or impact fund should be able to precisely measure their impact: managers can say how far each investment is reducing carbon or road traffic deaths according to reports and statistics. They also regularly engage with the companies they invest in, ensuring they are striving to meet targets.

Conversely, an ETF tracking the shares of thousands of companies based on an algorithm is unable to measure its positive impact, nor engage with the companies it invests in.

Extra importantly, ethical and ESG approaches may not outperform in the way that more rigorous sustainable and impact portfolios have been shown to do, as they are simply excluding a few companies from main markets.

Indeed, in its literature for its new funds, Nutmeg says it actually expects its socially responsible portfolios to underperform its other offerings because the extra costs of investing ethically through passives are not matched by reward,[2] as they are in more active strategies.

A step in the right direction

Again, it is important to commend Nutmeg, Wealthify, Moola, Wealthsimple et. all for their efforts. Despite the angry cries of determined detractors – be they of vegetarianism or ethical investment – striving for a better world is not an all or nothing game and doing something is better than doing nothing.

Moreover, plenty of other robo-advisers do not offer any form or ethical or responsible portfolios, including Moneyfarm, IG Portfolio and Scalable Capital.

Passive investment approaches like the ones robo-advisers employ have opened up financial markets to millions of less wealthy investors and are playing an accordingly increased role in all kinds of portfolios.

However John Ditchfield, partner at Castlefield Advisory Partners, warns those interested in investing in sustainably or ethically to choose their passive approaches carefully.

“For products that are ETF-backed, it’s really difficult to see how they will achieve anything other than drawing more capital into big businesses that are able to invest in obtaining the best ESG ratings simply through better reporting.

“The better funds consider outputs so will look at what a company actually does and how it impact the environment or society rather than focusing on what is says it’s doing. I think there’s an important distinction.”

Kelly adds: “There is still much work to do to move beyond ESG algorithms and embrace holistic ways of assessing investments.”

Check out the latest Good Investment Review for Good With Money’s pick of some of the best sustainable funds on the market

[1] https://www.statista.com/outlook/337/100/robo-advisors/worldwide#market-revenue

[2] https://resources.nutmeg.com/sri/sri-white-paper.pdf (p.28)

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