Help Clients Align ESG Investments With Their Goals

It’s clear that environmental, social and governance investing, or ESG, is growing in popularity among investors and is a topic of interest to financial advisors‘ clients. But what’s not so clear is how ESG criteria are defined, and whether well-intentioned investors are putting their money into companies that are actually aligned with their values.

ESG is a term coined in a 2004 United Nations report that called for more inclusion of such values-based approaches in investment decisions. The trend toward ESG investing began accelerating rapidly in 2018. Last year, assets in ESG-focused funds grew 53% over 2020, according to data published by Morningstar.

In the past few years, ESG has become an increasingly wide-ranging buzzword for a variety of investment styles. For example, it may mean avoiding investments in industries such as fossil fuels or gun manufacturing. Other times, it means favoring investments in areas like solar and wind power.

But determining whether an investment fits the bill is sometimes easier said than done. Richard Gardner, CEO of Modulus, a fintech firm in Scottsdale, Arizona, that develops white-label financial exchange platforms and technologies, cites a 2021 study published in The Economist that found that the world’s 20 largest ESG funds held investments in fossil fuel producers.

“Many also held investments in oil producers, as well as firms in the coal mining, gambling, alcohol and tobacco industries,” he says. “One of the problems with ESG funds is that there is no standard rating system, so simply investing in a given ESG fund may not align with an investor’s values.”

Faced with this conundrum, advisors can guide clients toward a better understanding of ESG investing while helping them sidestep such pitfalls. Here are some factors for advisors to consider when helping clients accomplish their ESG goals:

— Know the terms of ESG investing.

— How investors can learn about ESG.

— Look into multiple ESG strategies.

— Evaluate clients’ investing and ESG goals.

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Know the Terms of ESG Investing

In addition to the difficulty with ascertaining whether a fund really supports their environmental values, investors are often unclear on exactly what the “governance” part of ESG means and what criteria they should apply when selecting investments.

Governance risk includes a company’s legal and ethical management and financial policies, along with metrics regarding its stance on recruiting workers and being attentive to the environmental and social initiatives that are part of ESG investing.

Factors to consider under the “social” designation may include a company’s positions on issues such as working conditions, gender equality and relationships with the communities where it has a presence.

How Investors Can Learn About ESG

Understanding the factors of ESG investing is a gargantuan task. Investment management firms have research departments to help them sift through the data, or pay hefty fees for in-depth third-party research. So how can an individual investor possibly make good decisions when it comes to aligning investments with his or her values? That question is made more complicated by the vast number of ESG funds available today.

“Investors can’t really know whether an ESG fund truly reflects their values,” says Marjella Lecourt-Alma, CEO of Datamaran, a London-based company whose software identifies and monitors material ESG risks. “Some reassurance can come from a combination of how transparent the methodology is, how good the underlying data set is, and how achievable the execution of their stated strategy is.”

The average retirement investor probably has little training in evaluating a data set, Lecourt-Alma says, so focus on how funds are tracking improvements rather than static conditions.

“It might be more useful to focus on understanding how the fund is planning to ensure quality, improve quality over time, and then how much time, effort, budget or quality of people is being deployed to deliver this,” she says.

In fact, measuring progress along various ESG metrics is a key component of many fund methodologies. That’s how ESG funds can include fossil fuel producers or other types of companies that on the surface may seem contradictory to an ESG investor’s objectives.

“Investors are hearing conflicting messages about what ESG strategies are and whether they reflect values we hold close,” says Keesa Schreane, a global partner director at the London Stock Exchange and author of “Gambling on Green: Uncovering the Balance Among Revenues, Reputations and ESG,” due out later this month.

Look Into Multiple ESG Strategies

Schreane adds that there are various types of strategies available, such as impact investing, which is focused on investing for positive environmental or social outcomes. She also cites ESG integration, which incorporates sustainable information into established stock-selection methods. She says doing due diligence to understand these strategies can help investors align portfolios to their values.

She suggests that investors also review the sustainability report of a stock they are considering. “This gives insight into how the company is doing and likely gives insight into how far they’ve come in terms of several key sustainability issues,” she says.

For investors who find financial reports incomprehensible, Schreane has some advice: “If it’s a well-done report, it will be easier to read and more informative than other types of reports.”

Companies also take other measures to make their ESG progress transparent, says Krista Morgan, general partner at Stage Fund, a buyout private equity fund. For investors, it’s easier than they may think to do some basic, yet informative, research.

“Authentically sustainable brands and companies often gain certifications from reputable third parties, like B Corporation or Fair Trade,” she says. “Take the time to do a search on social media to see if there is action behind their words. Find influencers you trust, and give the companies and brands they support more weight in your investments.”

Morgan says there are other clues for investors as to whether an investment meets their ESG goals. “Fund managers that are actively pursuing an ESG strategy will often talk about it publicly to gain credibility,” she says. “Any materials will clearly highlight their strategy and why they believe it will generate superior returns versus having a fine-print ESG policy.”

Evaluate Clients’ Investing and ESG Goals

Bill Page, senior portfolio manager of Essex Global Environmental Opportunities Strategy in Boston, says there are ESG funds to meet every investor’s needs. But he says it’s important to evaluate investment goals, such as retirement, along with ESG goals. “Both can and should go hand in hand,” he says.

For example, if there is a particular global problem an investor is concerned about, a thematic fund, such as an index that focuses on water, may fit the bill. If an investor prefers to screen out segments of the market that go against his or her beliefs, an exclusionary fund may be a good fit.

But Page has a word of caution about the importance of investors knowing what they own. “There is no perfect company, and no ‘ESG stock,'” he says. “However, make sure you are comfortable with the investment process to which you are investing, and ensure the manager is providing optimal commentary.”

There’s a wealth of information available about investments and ESG, so do your research, Page says. “In fact, there is more relevant research on investment vehicles and companies now than ever before,” he adds.

Just as important, clients should compile a list of concerns they have as investors on certain issues, he says. They can then compose a list of the types of companies they want to research and possibly invest in, their main priorities, and the research and conversations they hope to have with you, their advisor, as they work toward their ESG investing goals.

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