Between wildfires in California, heatwaves in the Midwest, frigid cold snaps in Texas and rising waters from Miami to Maine, not to mention popular unrest and protests, it’s no wonder that sustainability and social impacts are driving investments.
Globally, sustainable funds — those that consider environmental, social and governance, or ESG, factors — had net inflows of $142.5 billion in the fourth quarter of 2021 alone, a 12% increase from the third quarter, according to Morningstar. Sustainable funds are growing at a faster rate than the overall fund universe, which saw a 6% increase in inflows.
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The rise in sustainable and ESG investing popularity is well justified: ESG funds have outperformed their non-ESG counterparts on average. ESG index funds that tracked U.S. large-cap indexes had average annual returns of 29.2% in 2021 compared to 28.7% for iShares Core S&P 500 ETF (ticker: IVV), according to Morningstar. Given these numbers, advisors who don’t discuss ESG with their clients are doing them a disservice.
To help you initiate and improve ESG conversations with clients, we spoke with Carol Schleif, deputy chief investment officer at BMO Family Office, who has earned a Fundamentals of Sustainability Accounting, or FSA, credential from the Sustainability Accounting Standards Board, or FASB. She shares more on why initiating these conversations is so important and how to guide clients through the ESG portfolio creation process. Here are edited excerpts from that interview:
Why should advisors initiate discussions with clients regarding ESG and impact investing?
Every investment we make has an impact by providing or withholding capital from a specific asset. Even before the pandemic and social unrest of the past 18 months, a growing set of investors were concerned with not undoing their philanthropic efforts by putting capital toward companies or industries that were positioned against values they hold dear. In thinking of a continuum between pure profit and pure purpose, many individuals have begun searching for a better balance than entirely one or the other.
This enlightenment has led to many other changes in our sensibilities: from where we live to how we work, who we hang out with and what activities we find important. Billions of dollars are flowing into ESG and impact-labeled investments. If we are not initiating these discussions with our clients, our competitors almost assuredly are.
In narrow terms, ESG investing can be a layer of risk analysis applied to assets to understand what sorts of potential risks or opportunities should be reflected in asset prices. For example, a regional bank with 75% of its loan book backing fracking loans may necessitate a different valuation than a multinational bank with a more diversified loan book. Or a hotel operator with the bulk of properties in coastal hurricane zones versus Iowa farm country. An advisor needs to focus on asking lots of questions and tailoring the answers to their clients’ strategies.
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Is ESG right for all clients?
There is no one-size-fits-all solution for a compliant ESG or impact portfolio. We each have a unique set of values that we may or may not seek to express through our investments. For example, one person with a core desire to benefit the environment may feel strongly about investing in electric cars. Another individual may find the lithium mining to build batteries abhorrent.
The key is to figure out what values each client is most intent upon expressing and then search for managers and investments that most closely align. Advisors also need to understand that some clients will choose to keep their profit and purpose goals separate, maximizing growth in the portfolio no matter the means, to have a larger base to gift from.
How should advisors start these discussions with their clients?
Advisors can struggle to initiate conversation on topics that feel softer than pure metrics-based dialogs. Keeping the focus on asking clients what’s important to them and what they may or may not want to express in their portfolios is a good way to start.
Initiating this discussion can be as simple as: “Are there industries or companies that you prefer we emphasize or avoid as we manage your assets?” Or: “How do you feel about investing some or all of your portfolio to reflect specific values or beliefs you hold?”
How should advisors manage their clients’ expectations for ESG portfolios?
It is important for clients to understand there’s no single right way to deploy an impact portfolio. The finance industry itself — both in variety of investments and data analytics — is a work in process. Interest in types of investments and measurement of outcomes, as well as the explosion in assets under management in the industry, are helping to drive better options. However, there is a long way to go.
Impact measurement is better today than ever before, but consistency and comparability challenges remain. A variety of organizations from the Financial Accounting Standards Board, or FASB, to SASB, the Global Reporting Initiative, the CFA Society and the United Nations all have different efforts afoot to drive toward more usable data for investors. The SEC and FASB are considering tougher reporting rules for companies, especially as they relate to the impacts of climate change on operations.
Advisors can encourage interested clients to find investments that fit into the client’s hierarchy of priority. Don’t allow the pursuit for perfection to forestall getting started. Build a framework around what values are most important to you and how they might be expressed in your investments.
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Q&A: How to Have Better ESG Conversations With Clients originally appeared on usnews.com
