Morningstar's Hortense Bioy (pictured) said the success of the UK labelling regime will lie in the quantity and quality of the products that get labelled.
Up to 300 UK open- and closed-end funds will opt for one of the four sustainability labels introduced by the Financial Conduct Authority by the end of this year, Morningstar has estimated.
The firm said this was "an optimistic scenario" and noted that labelled funds may represent 8% of funds domiciled in the UK and less than 3% of all funds available for sale in the country, amounting to roughly £110bn in total assets.
By comparison, the financial regulator estimated in its Sustainable Disclosure Requirements policy statement in November that around 280 funds that currently have key sustainability-related terms in their name or objectives will use a sustainability label.
Neither the FCA or Morningstar take into account new funds that will be launched this year and may opt for a label.
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Based on its assessment of the 300 funds, the firm is predicting that ‘Focus' will be the dominant label, representing almost half (46%) of labelled products, followed by ‘Mixed Goals' (31%), ‘Improvers' (12%) and ‘Impact' (11%).
Of the four labels, Morningstar said asset managers have the best understanding of the Focus label and the type of strategy that will qualify for this label, given its parallel with SFDR, despite questions about what constitutes a "robust and evidenced-based standard".
Some fund houses also acknowledged the appeal of the recently introduced Mixed Goals label, due to its flexibility.
The label allows asset managers to divide portfolios and allocate as many assets to sustainability objectives as they see fit, provided that 70% of the aggregate assets align with the criteria of at least two of the other three labels.
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Morningstar's analysis also found equity funds are likely to represent over half of the labelled product universe, while fixed income and passive funds will be significantly underrepresented, each accounting for less than 10% of labelled products.
"Most passive funds available for sale in the UK (1,960 in total) are overseas exchange-traded funds, typically domiciled in Ireland or Luxembourg, which are currently out of scope," the firm said.
"The limited number of labelled passive funds will reduce the choice offered to sustainability-oriented investors in the UK."
However, the firm noted there should be more options in the labelled allocation funds space thanks to the introduction of the Mixed Goals label.
When the naming and marketing rule comes into force on 2 December 2024, asset managers will consider investor demand, competitive pressure and the benefit of clarity as reasons for using the labels, Morningstar said.
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However, the firm said some managers may also find the requirements too restrictive, instead opting a cautious approach to wait and see how the market of UK labelled products develops.
"The success of the UK labelling regime will lie in the quantity and quality of the products that get labelled," said Hortense Bioy, global director of sustainability research at Morningstar.
"We expect conversations in the next few months and the first wave of implementation later this year to determine how this market will shape up.
"We hope this early analysis will contribute positively to these conversations for the benefit of investors not only in the UK but also other jurisdictions as they look to implement similar regulatory frameworks".
