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The December ESG Quick 5

Gabe Rissman, president of YourStake, provides his take on the top ESG news items and research findings from 2021 that advisors need to know, with a look ahead to 2022.

COVID-19 and Black Lives Matter made 2020 the inflection point in ESG awareness. ESG adoption and mainstreaming was the story of 2021. Many signs point to 2022 as a year of reckoning for ESG. This year, greenwashing catapults to top of ESG concerns; regulation is poised to shake up ESG; investors move toward personalization; shareholder engagement gains power; and ESG goes mainstream. Let’s break it down:

  1. Greenwashing Catapults to Top ESG Concern

Ever since the modern Socially Responsible Investment movement began in the 1960s, financial performance has been the top investor ESG concern. But as ESG interest has grown, greenwashing, or the practice of companies’ and fund managers’ sustainability marketing outpacing actual “green” practices, has increased in prominence. After years of empirical evidence and studies dispelling the myth of poor financial performance, greenwashing and data quality have now become the top issues for sustainability-oriented retail and institutional investors, in the United States and around the world. Surveys from Schroders, Capital Group, Federated Hermes and more all reached similar conclusions in 2021.

What does this mean for advisors in 2022?

In 2021, many advisors were able to find success offering generic ESG solutions without much pushback. As advisors differentiate their practices based on ESG in 2022, wealth managers will need to understand exactly what their fund managers’ ESG strategies are to avoid client pushback. One of the biggest risks an advisor faces is recommending an ESG fund that makes the news for being accused of greenwashing. There’s additional regulatory pressure to ensure clients that desire sustainable solutions are not being misled, which also leads perfectly to the next major trend in ESG: regulation.

  1. U.S. and E.U. Regulation Is Poised to Shake Up ESG in an Effort to Bring Standardization.

Regulatory bodies recognize the investor attention being paid to greenwashing and are looking to step in. The regulators’ goals are largely to protect investors from misleading marketing, but government regulation of ESG disclosures is also intended to drive progress forward on social and environmental issues like climate change.

In the U.S., the SEC issued an ESG risk alert and is taking a multi-pronged approach to increase mandatory disclosures around climate change, human capital and board diversity. SEC Chair Gary Gensler said “investors should be able to drill down to see what’s under the hood of these funds,” and has directed the SEC to assess “whether fund managers should disclose the criteria and underlying data they use.” The EU is further along, having specified 18 data points for mandatory disclosure by 2023 as part of the Sustainable Finance Disclosure Regulation (SFDR).

What does this mean for advisors in 2022?

ESG regulations are needed because investors do not have access to the information they need to make sustainable investing decisions. Especially as more investors see ESG factors as material, they need to be able to make apples-to-apples comparisons across a range of metrics and disclose their own process to their constituents. A lack of disclosure also obscures the nuance of one-size-fits-all ESG scores, meaning advisors might recommend positive ESG investments that don’t actually align with their clients’ values. This challenge leads to the next trend: personalization.

  1. Investors Move Toward Personalization

ESG has gained so much popularity that it has become a catch-all term to refer to all aspects of sustainable investing. I’m guilty of this myself.

In its purest form, ESG investing is the practice of using environmental, social and governance factors in an effort to reduce risk and generate financial outperformance. In this framework, the underlying question is “how well is this investment able to manage ESG risk and capitalize on opportunity,” which has an objective, correct answer. ESG investing in this way lends itself to one-size-fits-all ESG scores based on analyst research.

On the other hand, many investors are looking for something more in addition to financial performance. Many are shocked to see that ESG scores are more focused on the impact of ESG risks on a company’s bottom line than the impact of a company’s operations on social and environmental progress.

What does this mean for advisors in 2022?

When investors say they want “ESG,” they often mean they want to align their investments with their values and contribute to societal improvement on the issues they care about most. Some are guided by principles-based values alignment that formed the basis of traditional “socially responsible investing” (SRI). For example, a client that lost their mother to lung cancer might not want to invest in tobacco companies regardless of the company’s financial performance merits. Other investors might be passionate about fighting climate change and prefer a “thematic investing” approach that focuses on building a portfolio around climate solutions.

For these clients, one-size-fits-all ESG approaches do not work. Individuals that care about data privacy might not want to invest in companies that don’t protect customer data, even if the company has a great ESG score driven by its leadership in diversity or energy efficiency.

Advisors should focus first on discovering client values, and can use an ESG questionnaire to guide that process. Advisors should also know how to offer advice to clients with diverse sets of social and environmental values, and be prepared to talk about the trade-offs that exist along different ESG lenses. Finally, advisors should be aware that investors are increasingly looking for their fund managers to lead in the next trend: shareholder engagement.

  1. Shareholder Engagement Gains Power

Engine No. 1’s success in gaining three seats on Exxon’s board of directors received the most attention in 2021, but shareholder engagement has been steadily gaining influence over the past decade. Mega investor collaborations like the Climate Action 100 have pushed the world’s largest carbon emitters to set science-based climate targets and stop obstructing climate policy. The 2021 proxy voting season rewrote the record books as ESG shareholder resolutions achieved high levels of support from retail and institutional investors alike.

What does this mean for advisors in 2022?

Proxy voting and shareholder engagement are arguably the most effective ways for investors to drive social and environmental progress. And many of the largest fund managers that were called out for voting records that contradicted their investment processes have now changed their proxy voting policies to support ESG shareholder resolutions. At the same time, Robinhood’s acquisition of investor communications platform Say Technologies, and BlackRock’s move to allow asset owners to set custom proxy voting policies, signal the investor world trending towards more access and participation in shareholder engagement. Advisors should be prepared for an explosion of interest in shareholder engagement in 2022/2023 as evidence of success continues to pile up, and channels for participation open up.

  1. ESG Goes Mainstream

All in all, the biggest trend in ESG in 2021 that will carry into 2022 is growth. 2021 asset flows more than doubled 2020 asset flows. The number of new sustainable funds hit an all-time high. Ninety-five percent of financial advisors say their clients have asked them about ESG. Startups with ESG capabilities were acquired by some of the biggest players on Wall Street. The latest projections don’t anticipate ESG slowing down.

What does this mean for advisors in 2022?

In my own experience, talking to advisors about ESG every day, I’ve seen advisor-client conversations change. In 2020, advisors were only getting a couple questions from clients about ESG, and started learning. In 2021, advisors started to see the writing on the wall, and began using ESG tools and building solutions. In 2022, ESG leaders and laggards will emerge among the largest players in the wealth management space, and their success or failure in catering to a values-oriented audience will be a key determinant of asset flows. Every advisor will receive questions from their clients in 2022, will need to engage with their clients about social and environmental issues, and will need a thoughtful solution to serve values-aligned investors.

All that said, ESG will see its speed bumps this year. Already a BlackRock fund lost 91% of assets in the last week of 2021 for undisclosed reasons. Some fund managers will face hurdles from government regulation, and there will continue to be confusion around what constitutes “real ESG.” It’s very clear that there’s no turning back from the principles behind ESG investing. Investors want to buy products they believe in, work for companies they support, and invest in alignment with their values, and advisors need to serve those needs.

Gabe Rissman is the president and co-founder of YourStake, a platform to help wealth and asset managers to build custom ESG portfolios and provide personalized ESG reporting.

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