For the uninitiated, the world of virtuous investing is becoming increasingly complex.
Environmental, social and governance (ESG) got the ball rolling and remains the dominant form of conscientious investing, but there's more to the game. Traditional ESG indexes typically exclude companies in the alcohol, tobacco and gambling industries, makers of civilian firearms, purveyors of adult entertainment and obvious energy/climate offenders.
Sustainable investing builds on that concept by combining ESG and financial factors. An easy weigh for advisors to explain this to investors is by highlighting that, in a perfect scenario, sustainable investing is a best of both worlds approach. It aims to generate impressive returns while weighing that objective against ESG implications.
“Sustainable investing is about investing in progress, and recognizing that companies solving the world’s biggest challenges can be best positioned to grow,” notes BlackRock. “It is about pioneering better ways of doing business, and creating the momentum to encourage more and more people to opt in to the future we’re working to create.”
That's a lot of feel good jargon there, but the reality is advisors need to be prepared for this conversation because, per BlackRock data, mutual funds emphasizing sustainable investments could have close to $2 trillion in combined assets under management by 2028 while exchange traded fund counterparts could approach $500 billion.
Marrying Sustainable and Thematic
As noted above, many ESG funds are prosaic in approach and sustainable funds simply build on that foundation, often in basic fashion.
Fortunately, a growing number of thematic funds tap into the sustainable vibe, presenting advisors with compelling alternatives to put before advisors. And don't scoff at the notion of going thematic in the sustainable arena. At the end of 2020, there was $104.1 billion in US-listed thematic ETFs, many of which possess sustainable investing objectives.
Advisors may want to consider this approach for another important reason: The sustainable/thematic combination is a prime avenue for engaging younger clients.
“Looking at investor demographics, both thematic investing and sustainable investing notably appeal to younger investors: 83% of millennials said they were 'extremely interested; or 'very interested' in thematic investing according to a Global X-commissioned 2017 survey, while 86% of millennials expressed interest in sustainable investing, according to a Morgan Stanley survey in the same year,” notes Global X.
Obviously, many advisors are already hip to the fact that millennials are hitting their prime earning years and that the demographic, along with Gen X, is part of the expected, massive transfer of wealth from Baby Boomers. Said another way, there's no time like the present to talk sustainability with younger clients.
Differentiation Matters, Conscientious Clients Will Appreciate It
For as popular as ESG investing is, there are still issues surrounding complexities in ESG scoring that make it difficult to ascertain whether or not an investor is allocated in truly sustainable fashion. For example, many technology companies score well on an environmental basis, earning entry into ESG benchmarks, but some of these firms have gender pay gaps and low percentages of minority workers.
Second, old guard ESG investing makes it difficult for investors to easily realize exactly what the impact of their supposedly sustainable allocations is. This is where well-informed advisors can chime in, highlighting the benefits of differentiation between ESG and sustainability.
“Compared with ESG integration, impact investing draws a clearer line between one’s investment dollars and achieving a specific outcome,” according to Global X. “Industry definitions of impact investing limit much of a public equity investor’s opportunity set, given the requirements on measurability of impact and 'additionality', the latter of which means 'only allocating to businesses that they would not otherwise choose to invest in if they were not seeking to achieve a positive social impact.'”