The widely followed MSCI USA Extended ESG Select Index is down 21.65% year-to-date, as of Nov. 2, which is slightly worse than the 221.07% shed by the S&P 500.
That’s not an alarming gap, but it illustrates some of the vulnerabilities of associated environmental, social and governance (ESG) in certain market environments. As advisors and clients are learning, 2022 isn’t a favorable time for ESG funds owing to the fact that many of these products are overweight growth stocks, which are struggling mightily this year.
Still, advisors need to be aware of the point that inflows to ESG funds – though not as strong as what was seen last year – are continuing. That’s a sign many clients, particularly younger ones, remain committed to values-based investing.
All of that is to say that despite this year’s less-than-inspiring showings, ESG remains a priority for many clients and advisors need to be attune to that demand.
Value Add, Not Values Imposed
Many advisors know that there’s controversy swirling around ESG investing and much of it is political in nature. Long story short, there are plenty of investors, including current and prospective clients, that view ESG as an imposition of values – values that don’t align with their own.
The elixir is simple. Advisors discussing ESG with clients need to frame in terms of optionality, not as a necessity. Articulate the pros and cons to clients without making an endorsement.
“The point is, rather than representing values in and of themselves, these material ESG considerations are factors to consider when pursuing long-term value. And, notably, the data behind these factors continues to improve,” says Brie Williams, head of practice management at State Street Global Advisors (SSGA). “Managing investment risk means quantifying the impact of potential losses due to climate change exposure, unsafe working conditions, or excessive executive compensation. In our view, ESG investing is first and foremost a risk-management tool.”
Of course, with the aforementioned laggard performances this year, ESG’s ability to deliver the goods is sure to be top of clients’ minds and rightfully so. However, some experts argue the conversation should be framed in terms of risk mitigation, not pure performance.
“ESG investing isn’t one thing, or three things, or a set of investment strategies. It’s a process designed to mitigate risk and create long-term value — a lens to view investments through, not an end in itself. In this sense, ESG investing is more than a trend; it’s the way forward,” adds Williams.
ESG Evolution, Personalization
SSGA’s Williams highlights some other points about ESG, including the ability of the strategy to play a prominent role in legacy planning. Others include the fact this is very much a style that’s evolving and one that, perhaps to the surprise of many clients, can be customized.
ESG “becomes more profound with legacy planning, as clients think about passing their money along to the next generation, who may tend to be more engaged on ESG. ESG investing isn’t a short-term trend, or a tactical move to implement new funds. It’s about taking a longer-term view of investing — maybe one with generational implications,” she noted.
Bottom line: Approach ESG as you would any other concept. What works for one client may not be appealing to another, but there are suitable solutions in this space for a broad swath of clients.