Talk To Your Clients About ESG As Risk Management, Not Politics

Michael Madden, Contributing Editor & Research Analyst, Wealth Solutions Report

Expert Says ESG Is For Risk Management And Improved Returns – Not Politics, Describes The Risks Of Not Discussing ESG With Clients And How To Broach ESG Without Politics

In an era when political temperatures run hot, we often play it safe by avoiding the discussion of any topics that might be viewed as political. Though avoiding contentious issues with clients may be the right move in some situations, at times this can cause advisors to miss important issues with clients simply because a given topic has become politicized – such as ESG.

Andrew Poreda, VP & Senior Research Analyst, Sage Advisory

To understand what ESG is – and isn’t – and how that affects clients, we spoke with Andrew Poreda, VP & Senior Research Analyst in the ESG and impact investing group of Sage Advisory, which began to integrate ESG into its investment processes in 2005. The firm deploys strategies for ESG and impact investing, provides an annual ranking of sustainable corporate bond issuers and develops educational resources on ESG and SRI.

The firm experienced 35% growth in assets under management for the year ended July 31, 2023, and was named by Investment Metrics as having the top annual inflow for 2022 in the ESG intermediate strategy category.

We asked Poreda about the difference between ESG and SRI, ESG’s true purpose, the pitfalls of not raising ESG to your clients and how to broach the topic while sidestepping politics.

WSR: Explain the difference between ESG and SRI.

Poreda: ESG (environmental, social and governance investing) and SRI (socially responsible investing) often get lumped together, but there are differences. ESG is a process that harnesses qualitative and quantitative data to drive the risk management process and identify opportunities for long-term value creation.

ESG is meant to improve returns

As investors, we are concerned about how certain factors impact a company’s bottom line, and ESG was created to fill information gaps on past areas that investors had either overlooked or underappreciated and add a different but complementary layer to traditional fundamental investment analysis. ESG is meant to ultimately improve long-term risk-adjusted returns.

SRI takes an approach to investing through a values-tinted lens and is meant to align a client’s investments through various ethical or moral views. Usually done through some sort of negative screening process, investors who go down this path are deliberately acknowledging that investment decisions made may affect overall portfolio performance.

WSR: Is ESG political? If not, what’s its true purpose?

Poreda: ESG is currently being painted as an opportunity for asset managers to impart a progressive agenda, but that isn’t its intended purpose. ESG was created to identify and manage factors that were non-financial yet financially relevant.

In a world where some companies are acutely exposed to physical and transition risks associated with climate change, there are going to be winners and losers based on how this situation unfolds globally. And in an economy where intangible assets like human capital comprise most corporate assets, workers will play a critical role in the success of every corporation. Employees are clearly a valuable commodity, but what information exists on them in traditional financial statements?

ESG is a needed evolution to complement the financial and accounting disclosure world that was largely crafted in the middle of the 20th century, which inadequately reflects the service economy we live in today.

WSR: How can ignoring ESG lead to trouble down the road for advisors?

Poreda: ESG analysis is a process that provides an additional layer of valuable information to help make informed investment decisions. ESG has already become so embedded in the investment landscape that we are likely past the point of no return. As an example, all three major credit rating agencies have integrated ESG into their evaluation methodologies. (Despite recent changes, S&P continues to integrate ESG into its methodology.) The CFA Institute now includes ESG in its exam material while also offering a separate ESG Investing certificate.

Client acquisition may become a larger problem for advisors. As the millennial and Gen Z populations grow older, their influence will grow. As employees, they will move into leadership positions. As consumers, they will exert more purchasing power. And as investors, they will put more money into retirement accounts and other investment vehicles. ESG issues are important to them and communicating about investing through this lens is a great way to connect and better understand their investment objectives.

WSR: How can advisors broach ESG as a topic with clients while sidestepping the political issues?

Poreda: Advisors can be rewarded for spending time discussing ESG risks and opportunities with their clients. Many companies address ESG issues such as biodiversity, workplace safety, cybersecurity and business ethics. An advisor who understands how their clients view these issues can help them better align their investment goals with the issues they care about.

It is also imperative to remind investors that knowing about financially relevant ESG risks and opportunities provides more information, and well-informed investors make better decisions.

Michael Madden, Contributing Editor and Research Analyst at Wealth Solutions Report, can be reached at mmadden@wealthsolutionsreport.com.

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