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ESG Investing: The Growth Opportunity That Most Advisors Miss

There’s a critical need to acknowledge clients' sincere desires to invest with purpose.

Most asset managers know that environmental, social and governance criteria are emerging mainstream finance metrics. More than half of the global assets today, $59 trillion, are controlled by asset managers or owners who consider ESG factors.  The results are there too: thousands of studies since 1970 show a positive relationship between ESG criteria and corporate financial performance.

But recent studies also reveal that individuals and asset owners are seeking ESG investment options at higher rates than financial advisors are offering them. Advisors that haven’t yet started offering sustainable investment options are missing the opportunity to connect more deeply with clients by understanding what’s important to them beyond the usual topics like retirement, education and vacation homes.

So why aren’t more financial advisors seizing this growth opportunity? Three prevailing myths stand in the way of advisors viewing ESG factors as part of their fiduciary duty to clients. 

Myth #1 – My clients don’t care about ESG investing

Many wealth managers don’t want to add extra expenses to their investment process if their client base isn’t yet asking for ESG investments, but the tides are changing.

A Morgan Stanley study showed that 71 percent of individual investors are interested in sustainable investing, while more than 60 percent of advisors have little or no interest. The disconnect is clear, but advisors aren’t seizing the opportunity.

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ESG-investing interest is greater among millennials, as the chart above by Morningstar shows. Seventy-five percent of millennials say they consider social, environmental or governance factors when they invest and are set to inherit $30 trillion in assets by 2030. With that in mind, it’s critical to keep pace with what’s important to them. Understanding their motivations will be essential for continued growth. 

Myth #2 – Advisors talk about ESG, but no one really does it.

 A Legg Mason survey found that 69 percent of advisors say the importance of ESG investing has increased over the past five years, and they expect this growth to continue. In the chart below, you can look across the pond to Europe to see a 26 percent increase in sustainable assets under management from $8.6tn in 2012 to $13.6tn in 2014.

While the United States’ sustainable assets represented only $3.7tn in 2012 and $6.6tn in 2014, that represented a 33 percent increase in just two years. The pace of that growth has continued at 33 percent between 2014 and 2016.

 

Myth #3 – ESG Investing hurts financial performance

Advisors should consider incorporating ESG factors in the investment process as part of fiduciary duty, because it makes financial sense.  A University of Oxford study found that companies with robust sustainability practices demonstrate superior and more stable operational performance over time. The research also found that consistent application of sustainability practices has a positive influence on investment performance, for example:

  • 90 percent of the studies on the cost of capital showed that sound sustainability standards lower the cost of capital of companies.
  • 88 percent of the research showed that solid ESG practices result in better operational performance of firms, which translates into cash flows.
  • 80 percent of the studies showed that stock price performance of companies is positively influenced by good sustainability practices.

Furthermore, a Bank of America Merrill Lynch study found that if investors routinely select companies within the top quintile of ESG rankings, they enjoy lower price volatility and less severe price declines in their portfolios, with all else equal. Additionally, if investors only held companies with above-average ranks on environmental and social scores, they would avoid most of the companies that filed for bankruptcy within a five-year period considered in the study.

How to incorporate ESG into your practice?

First, advisors need to determine the right ESG data and software tools to address their clients’ needs. There are traditional ESG data providers that offer ESG scores and research based on company disclosures and new firms that use artificial intelligence to measure actual ESG performance as events occur.

Second, their ESG data solution should help advisors to monitor and report on ongoing changes to the ESG scores of the companies. There should be an easy-to-share interface and reports that help advisors to communicate clearly with clients on why they should or should not be invested in specific companies.

Lastly, educate your clients on why ESG is important even if they haven’t asked for it specifically. Aligning financial advice with individuals’ motivations and values and helping them invest in what matters most to them can be one of the most powerful ways to attract and retain clients. 

Susan Lundquist is the chief marketing officer for TruValue Labs. She's participating in a marketing panel at the Wealthmanagement.com Executive Forum on Oct. 11.

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