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Finding the right adviser for sustainable growth
Anthony Davidow writes that financial advisers can help investors align their purpose with their portfolio.
By Anthony B. Davidow
(About the author: Tony Davidow is president and founder of T. Davidow Consulting, an independent advisory firm focused on the challenges facing the financial services industry. His focus is on helping advisers and investors incorporate complex strategies in their portfolios.)
WILTON, CONN. (Callaway Climate Insights) — Over the past several years, there has been increasing interest in sustainable investing, with a slew of new products coming to the market claiming to “do well and do good” at the same time.
For investors, there are questions related to this trend. Do all strategies screen securities in the same fashion? What’s the difference between ESG and SRI? Do their results lag the overall market?
A 2019 study by New York Life Investments found that “... only 20% of investors surveyed had financial advisers who recommended using an ESG strategy — while 38% of the respondents said they had an “extremely high interest” in discussing these strategies with their financial adviser.”
For investors who are considering ESG strategies, allow me to suggest a checklist:
What are your views on ESG / Impact investing?
Are you willing to have results that are different from the overall market?
How does the portfolio manager screen and weight securities?
How long have they been incorporating ESG?
What is the experience and tenure of key personnel?
What has been the track record in managing ESG?
Though not impossible, this is a lot for investors to do on their own. The challenge is finding an adviser who understands, embraces and utilizes ESG investments. Financial advisers should seize the opportunity to educate investors on the challenges with ESG.
Understanding the terminology
The financial services industry doesn’t always make things easy for investors. We often use jargon and terminology that is confusing. We use terms like: ESG, SRI, impact and sustainable investing interchangeably — but there are substantive differences.
Environmental, social and governance (ESG) — Screens and weights securities based on company practices.
Environmental: climate impact, energy consumption, use of natural resources, carbon footprint, etc.
Social: employee engagement, human rights, gender diversity, labor practices, etc.
Governance: board independence, executive compensation, internal controls, and shareholders rights among other factors.
Socially responsible investing (SRI) — Originally introduced as negative, or exclusionary, screening of securities to align with investors views and preferences (i.e., anti-apartheid, sin stocks, reducing carbon footprint, etc.). Used largely by endowments, foundations, pension plans and family offices.
Impact investing — Investments designed to have a direct influence on social or environmental change. Typically accomplished through the private markets. Used by institutions and large families as a means of aligning purpose and values by funding specific causes (water purification, alternative energy, development of vaccines, etc.).
Sustainable or responsible investing — Used broadly to describe an investment philosophy that incorporates ESG factors in developing investment solutions. There may be a great deal of variability of how strategies incorporate these factors. It aligns an investor’s values with his/her portfolio.
Do these strategies lag the market?
Critics often claim that ESG strategies come with a performance haircut, and investors could choose to make charitable contributions rather than adopting a new investment approach.
Unlike SRI, which incorporates exclusionary screening, several reputable studies have shown that ESG strategies have outperformed their comparable indexes over the long run.
According to first-quarter 2020 Morningstar data, “The returns of 70% of sustainable equity funds ranked in the top halves of their categories and 44% ranked in their category's best quartile.” In addition, 24 out of 26 sustainable index funds outperformed their conventional counterparts. These results shouldn’t be surprising. Good companies with sound policies and engaged employees should do better over time.
Based on investor interest, there has been a plethora of new sustainable investing products coming to the market over the past couple of years (mutual funds, ETFs and and separately managed accounts). Investors need guidance in selecting the right solutions.
In a world where advisers are under pressure to demonstrate their value to investors, ESG represents an opportunity to distinguish their value proposition.
Rather than being perceived as a product pusher, they are engaging investors and delivering solutions. Financial advisers can add considerable value to investors by understanding their needs and aligning their purpose and portfolio.