The June issue of WealthManagement magazine contains a number of articles, as well as some benchmarking research, on socially responsible investing and its more contemporary iteration—environmental, social and governance funds.
These investment strategies are portfolios that take more than financial factors into account when screening for securities. In the case of SRI, companies may be excluded from a portfolio based on the explicit ethical values stated in the fund’s mandate; ESG takes it a step further, tilting a portfolio based on where its components rank in terms of exposure to risks associated with environmental impact, corporate governance or the treatment of its workers or the workers of its suppliers.
A common refrain we hear from some in the fund distribution world is that while SRI or ESG funds are great in theory, few retail clients of financial advisors are actually investing in them. Our research gets to the paradox: Advisors say they would offer these funds to their clients if their clients asked. But their clients aren’t asking. This begs the question: How can clients ask for something that their advisors haven’t offered?
That hasn’t stopped the asset management industry from jumping on the sustainable investing bandwagon, however. Over the past two years, Morningstar data shows the number of funds that have an intentional ESG mandate, based on a review of the fund’s documentation, increased by 42 percent to a current total of 273 funds. Meanwhile, a rough back-of-the-martini-napkin calculation shows that net new money going into all of these funds over the same time period has totaled $10.5 billion, or only 13 percent. In other words, the rate of sustainable fund launches is outpacing the rate of new money being invested in them. That trend is unsustainable.
The bet is this will change when current clients retire, and their children inherit their assets. Millennials, our research shows, will drive the change toward ESG funds. Many will see their parents’ money invested in high-cost, actively managed funds for even the core positions of their portfolios and look for alternatives. When they do, they likely won’t want to be involved in any funds that score low on Morningstar or MSCI’s sustainability ratings.
Only time will tell if that prediction is true or not, but I’m betting it is. As ESG evolves, it will become more widely recognized as a screen for the kinds of non-financial factors that investors intuitively understand, i.e., negative environmental impact, unstable foreign labor practices, demographically homogenous corporate boardrooms—all bad social risks and bad business risks. Show the next generation that ESG investing does not require a trade-off in performance (a topic for another day) and it’s likely that, unlike their parents’ generation, these new clients will ask for their advisors for it.
Editor in chief