When preparing for this roundtable I asked an industry veteran – aren’t SRI (Socially Responsible Investing), ESG (Environmental, Social and Governance) Investing, Sustainable Investing and Impact Investing essentially the same thing? I learned that ESG is SRI’s cooler younger sibling and “sustainable” is considered narrower than “impact.”
Our struggle with these investment strategies partially stems from a lack of common definitions. I wonder if we’re sometimes our own worst enemy – if we don’t create clarity, how can we provide it to our clients?
ESG-type themes occupy the top of mind for many advisors and consumers even if they don’t recognize it. Recently a leading financial advisor shared with me that he started a family foundation with the sole purpose of giving away half of his money. The desire to make a difference and invest in causes aligned with our passions strengthened due to our experiences of the past few years.
Why are there still headlines questioning whether ESG is a fad or permanent? There’s a generation gap in recognizing its validity as well as data suggesting female clients are almost twice as likely to want companies they invest in to integrate ESG factors into their policies and decisions.
This brings us to our roundtable question for this month: “Is ESG a valid investment strategy?”
We appreciate the insightful responses of the following leaders in the wealth management investment solutions space:
- Shannon Larson, Senior Vice President, Platform Management and Product Development at Advisor Group, the nation’s largest network of independent financial advisors serving over 11,000 advisors and overseeing $475 billion in client assets.
- Dana D’Auria, CFA, Co-Chief Investment Officer of Chicago-based Envestnet, provider of a full range of tools, capabilities and resources that strengthen the relationship between advisors and their clients.
- Laura Lutton, Risk Pillar Lead, Director of ESG Product Management in Sustainalytics’ product management group. Sustainalytics, a Morningstar company, is a leading independent ESG and corporate governance research, ratings and analytics firm that supports investors around the world. Lutton previously was head of asset management solutions at Morningstar.
It’s fair to say that over the past decade wealth management firms and asset management firms haven’t all rushed to embrace ESG.
But in recent years, there has been growing recognition that ESG is here to stay and positioned to gain traction among investors and the financial advisors who serve them, with ESG funds now representing 10% of worldwide assets.
Yes, further regulatory clarity is needed to standardize definitions of the specifics of what ESG is and what it isn’t.
But in the meantime, rising levels of investor interest in ESG solutions reflect how significantly client priorities have shifted, and the risks for financial advisors who don’t align with the changing values of their clients.
And unfortunately, there does appear to be an industry-wide gap between what advisors think their clients want and what the clients want in the ESG realm.
Numerous industry surveys have cited a lack of demand for ESG as a reason why firms and advisors aren’t offering more of these solutions to their clients, yet a recent Cerulli Survey of US Retail Investors stated that 44% of investors “prefer to invest in an environmental or socially responsible way.”
For wealth management firms looking to offer options, start with a core offering and focus on education. This is not just for high-net-worth clients, as investor demand spans all account sizes, so consider that as you build your platform.
At Advisor Group, we’ve focused on delivering through our partnership with Envestnet impact overlay screens empowering personalization of client portfolios, that include 23 restriction criteria available, including best in class and specific restrictions.
We’ve also delivered impact focused model portfolios through BlackRock and Envestnet PMC. Direct indexing platforms will also continue to drive forward ESG as that is a key part of personalization available.
At the end of the day, investors want to be listened to and heard. For firms and advisors with respect to ESG investment solutions, the take-away is clear: Just because clients aren’t explicitly asking for ESG doesn’t mean they don’t want it.
The first thing to understand about sustainable investing is that it encompasses an extensive array of investments, data providers, ratings agencies, governmental authorities, and managers. When you’re talking about a world-change on the scale that ESG contemplates, things are going to get complicated. The great news is that individual investors now have choices they never had before. A diverse mosaic of personalized solutions is being brought to market that consider not only risk and return but also a deliberate discipline over what your dollars will support. And investment professionals have a tremendous opportunity to engage their clients on a deeper level.
The first step is to learn what is available to you. Informed advisors and managers will help clients navigate the questions in this new world: How much tracking error am I willing to take? What is the alpha thesis for a particular ESG opportunity? Is the investment in front of me designed to outperform or is it being framed as a consumption decision where I might want to accept a slightly lower return (maybe with reduced risk) in order to incentivize behaviors I care about?
Look askance at black-and-white predictions about the returns on seismic transitions like the one from shareholder to stakeholder capitalism or from a carbon-dependent to net-zero global economy. Sweeping claims that you simply cannot invest in your convictions and outperform the market or conversely that you will necessarily make more money in ESG investments don’t convey the fundamental truth that we are moving toward a world where all investing is at least ESG-aware. And as with all investing, some solutions will outperform and some won’t.
A recent Morningstar brand survey found that most U.S. consumers are already making sustainable choices in their day-to-day spending. About 40% of respondents said they were going out of their way to support brands and industries that they think will have a beneficial impact on the environment, while 30% said they are avoiding brands that have a detrimental impact on the environment or society. The same survey suggests demand for sustainable investments also is strong: More than 70% of respondents view sustainable investing as innovative and an opportunity.
The investment industry is responding to this demand with supply. Morningstar’s latest study of global fund flows found that asset managers launched more sustainable mutual funds and ETFs in 2021 than in any previous year, with more than 266 new offerings hitting the market in the fourth quarter alone.
Like those consumers seeking environment-friendly products, investors are sending more cash to sustainable investments. New cash into sustainable funds and ETFs hit a record in 2021. Investors directed $142.5 billion into sustainable funds in the fourth quarter, while the overall global fund universe notched a 6% decline in net new money.
The momentum behind sustainable investing is encouraging, but there’s more to be done. More than a third of the brand survey respondents said they had never heard of sustainable investing, while 29% had heard of the term but knew nothing about it. That lack of familiarity suggests that we all can do more to provide investors with a framework for sustainable investing. Regardless of the investor’s sustainable priorities – from avoiding risk to driving change, portfolios that reflect investors’ values are likely to be stickier and empower investor success.
Next Month’s Roundtable
More data allows us to make better decisions. ESG investing can provide both financial performance and impact. As assets grow, the tools that will help see investments through an ESG lens have also expanded because more asset managers and investors demand it. We still have a way to go – more education, commonality of terms and transparency around the impact of the investment and not just the return are still needed. Given the prevalence of the role of women in investing, and that much of the $68 trillion that is expected to change hands in the next 25 years will go to members of the Gen X and millennial generations, this is an area of investing that you cannot afford to ignore.
Thanks to Shannon Larson, Dana D’Auria and Laura Lutton for sharing expert insights on the growth and future of ESG investing.
Please send your ideas and suggestions for next month’s Investment Solutions Roundtable as well as your thoughts about today’s discussion of ESG.
We truly appreciate when you share what you learned in this roundtable with your friends and colleagues by LinkedIn, other social media or email.
Until next month, may you continue to find success in all you do!
Allison Pratt is a strategic advisor to C-suite teams and boards of directors for wealth management and asset management firms across the country. She can be reached at ContributingEd@wealthsolutionsreport.com