In Charts: ‘Focus’ label will dominate SDR funds in 2024, says Morningstar

The FCA’s Sustainability Disclosure Requirements regime offers four sustainability labels that asset managers may use from July

UK funds that opt for a label under the Financial Conduct Authority’s Sustainability Disclosure Requirements regime are most likely to choose the “sustainability focus” label, according to a new Morningstar report. 

In November 2023, the regulator published its policy statement on SDR, a voluntary labelling regime that divides funds into four categories: “focus”, “improvers”, “impact” and “mixed goals”. The regime will come into full effect in December, although funds may start using the labels from July.

Morningstar predicts that around 300 UK open and closed-end funds will pick a label by the end of the year under its most optimistic scenario. Labelled funds could account for 8 per cent of UK-domiciled funds and less than 3 per cent of funds available for sale in the UK.

It expects the focus label to be the most popular category. Funds within this group invest largely in assets that are environmentally or socially sustainable. “Of the four labels, it appears that asset managers have the best understanding of the focus label and the type of strategy that will qualify for this label,” Morningstar said in its report.

Managers drew a comparison with Article 9 funds under the EU’s Sustainable Finance Disclosure Regime that explicitly invest in sustainable assets, it continued. “Many were confident that strategies meeting the criteria for Article 9 … would meet the requirements for the focus label.”

The mixed goals label is also likely to be popular, Morningstar believes. The category was only added into the SDR in the FCA’s November update and covers funds that combine the attributes of the regime’s other three categories. Funds with the improvers label will invest mainly in assets with the potential to become more sustainable over time, while impact-labelled funds will invest largely in assets with a view to achieving a positive impact for people or the planet.

Managers liked the flexibility afforded by the mixed goals label, Morningstar said. “It should allow them to slice portfolios and create as many allocations to sustainability objectives as they see fit as long as 70 per cent of the overall assets are aligned with the criteria of at least two of the other three labels.”

The financial data provider predicts low take-up for the impact label, due to strict criteria set by the FCA that will require managers to evidence change at both investor and asset level. It said it will “remain a challenge for managers to show evidence of impact in the listed market” and found “very few” UK funds that targeted impact in listed equities.

Equities will dominate

Morningstar expects equities to be the dominant asset class under the SDR this year, followed by multi-asset – also known as “allocation” – funds.

“Equity remains the asset class where it is easier to integrate ESG factors,” it said. “ESG integration in fixed income strategies faces multiple issues, including data availability and quality. There is also the issue with evidencing sustainability outcomes in the case of sovereign debt.”

SDR-labelled funds will be largely active, Morningstar predicts. Of the 410 UK funds with sustainability-linked terms in their names, around 50 are passive, and it expects that fewer than half of these funds will choose a label. The majority of passive funds available in the UK are domiciled in the Republic of Ireland or Luxembourg.