ESG Adoption Barriers Are Declining. That's Good for Advisors

Environmental, social and governance (ESG) strategies are increasingly prominent parts of the everyday investment lexicon.

With more companies prioritizing climate sustainability and social justice issues, advisors should anticipate more conversations with clients regarding ESG funds and the applications of these products within portfolios. For advisors and clients alike, there's good news: Following a batch of strong performances last year, ESG funds are answering one of the primary concerns associated with this asset class.

“ESG products' strong 2020 performance and increasing demand from both institutional and retail investors could remove what has been a significant barrier to widespread ESG adoption among retail investors – namely, the concern that these investments require investors to sacrifice potential investment returns given constraints imposed by investing sustainably,” according to Moody's Investors Service.

Asset allocators are responding. Last year, open end sustainable funds, including exchange traded funds, added $51.1 billion in new assets with $20. 5 billion arriving in the fourth quarter alone.

Why Advisors Need to Prepare

There are multiple reasons why advisors need to get ahead of the ESG conversation, including a rapdily expanding universe of choices to mull for possible inclusion in client portfolios.

If this article was being penned in early 2016, I'd deliver the following the statistic: As of the end of 2015, there were 24 ESG ETFs and 115 such mutual funds on the market. Alas, we're talking about the early 2021 landscape, which now features of 392 ESG funds – 111 ETFs and 281 mutual funds – as of the end of 2020.

“Of the 392 sustainable funds, 269 are equity funds, 74 are fixed-income funds, and 47 are allocation funds. Investors have the most choices in U.S. equity, with 134 funds,” notes Morningstar. “Another 99 funds are either world-stock or international-equity funds. Among fixed-income funds, 26 are intermediate-term funds. Overall, investors can find sustainable funds in 65 Morningstar Categories.”

Another reason advisors need to bolster ESG preparation and resources is that this investing style is particularly appealing to younger clients. Myriad studies confirm as much, meaning this is an ideal way for advisors to make inroads with younger demographics and bolster retention of heirs when their older partents, etc. pass on. 

Due to millennials and Gen Z being around for major crises such as the global financial crisis and the coronavirus pandemic, these demographics are risk-aware. On the ESG front, that's a positive.

“ESG products’ risk/reward characteristics are similar to those of other types of investments, and studies suggest ESG constraints will not detract from returns,” notes Moody's. “Inflows to ESG funds in 2020 indicate that investors may already be less worried about any supposed sacrifice in returns.”

Good Timing

Putting personal politics aside, another reason for advisors to be proactive with ESG funds is that the political environment is increasingly favorable for further ESG adoption, including in employer-sponsored retirement plans.

“The Biden administration has reversed course from the previous administration's pullback from ESG initiatives, rejoining the Paris Climate Accord, reversing rollbacks of environmental rules (and planning to reverse more), and emphasizing growth in clean energy,” notes Moody's. “The administration has said it will immediately review the Labor Department’s rule potentially limiting ESG focused investments in 401(k) plans. Likely to have more impact is the new administration’s focus on renewable infrastructure, along with key political appointments that could influence investment regulations.” 

Bottom line: ESG is an avenue for advisors to deliver value to clients and this is a movement with momentum. Prepare accordingly.

Related: ESG Is Finally Making its Way to Smaller Stocks