Clients Are Getting Demanding About ESG Investing

The universe of environmental, social and governance (ESG) investing options is evolving and expanding. For advisors, this is broadly positive because ESG is an investment style a wide array of clients are apt to find appealing.

While it's often said that younger demographics (millennials and Gen Z) are the ones prioritizing virtuous investing, data confirm a wide swath of investors are getting hip to ESG and that opens doors for advisors to engage clients on an investment style many want to embrace but lack education.

“At the end of 2019, about $17.1 trillion—roughly one-third of all assets under professional management in the U.S.—was being managed using some type of sustainable-investment strategy or by institutions that filed shareholder resolutions on ESG issues, according to the most recent data from the US SIF Foundation, a sustainable-investing trade group. That was a 42% increase from two years earlier, the group said,” reports The Wall Street Journal.

For those not impressed by data from 2019, consider the following. Nearly every month, a new record assets tally arrives for ESG ETFs and in the first quarter of this year, $21.5 billion into ETFs and mutual funds using ESG or sustainability screening.

Growth Begets Clients Getting More Selective

The oldest iterations of ESG funds are addition by subtraction strategies. What that means is that in an effort to appeal to virtuous investors certain companies are excluded from the funds' rosters. Those usually consist of adult entertainment companies, civilian firearms makers and “sin stocks”, namely alcohol, gambling and tobacco equities.

That approach worked awhile ago and data suggest it still is, but in today's world where information is widely accessible, advisors should expect clients – particularly those wanting to have an ESG conversation – know a few things. Those are likely to include the fact that universe of publicly traded adult entertainment is sparsely populated and civilian gun makers are small-cap stocks. In other words, it's easy to build a large-cap strategy that excludes those companies because a large-cap index would be excluding them in the first place.

Another result of clients increasingly prioritizing sustainability is that many are scrutinizing legacy ESG funds and some aren't liking what they find.

As an advisor, put yourself in the clients shoes. If sustainable investing is a top priority, do you want to own a fund with “ESG” in its name only to find out it holds traditional energy stocks and companies that produce products in countries with dubious human rights track records? Probably not.

The opportunity here for advisors is immense and it revolves around guiding clients through evolving and new sustainability ideas – many of which go beyond a company's lack of environmental transgressions and complexion of its board and into concepts that really make the world a better place. Think healthy economics, education and financial services accessibility, food concepts and more.

Returns, Of Course

While clients are continuing to warm to the idea of virtuous investing, they, not surprisingly, still want to know if this way of doing things leaves them vulnerable to leaving returns on the table.

Broadly speaking, ESG funds have answered this call with aplomb, in many cases performing ahead of broader market benchmarks. However, not all are doing that.

For example, over the past three years, the S&P 500 beat the MSCI USA Extended ESG Select Index  by nearly 700 basis points with less annualized volatility. That's just one example, but it underscores the point that advisors can add tremendous value for ESG-focused clients by showing them that there are new sheriffs in town when it comes to sustainable investing.

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