The coronavirus pandemic and the widespread protesting that has resulted from police killing of George Floyd has combined to create a unique moment that financial services experts and advocates for impact investing believe will be a catalyst for bringing ESG investing to nearly every portfolio.
ESG, or “environmental, social and governance-minded,” investing, asset selection refers to investors setting aside pure profit motives and investing in companies that are good to the environment, their employees and their shareholders. The phenomenon has already been gaining momentum. According to a recent study by Deloitte Insights, ESG-mandated retail and institutional accounts in the U.S. grew at a compounded annual growth rate of 16% from 2014 to 2018, and now account for some $12 trillion in assets or a 25% share. As money continues to pour into sustainable funds and ETFs, many believe that share will rise to 50%.
“What we’ve seen from the health crisis is that Covid-19 actually accelerated investor focus on sustainable investing. Even through a volatile period in the market where you saw uncertainty and outflows from traditional funds, people were putting more money into sustainable investments,” UBS Global Wealth Management head of sustainable and impact investing Andrew Lee says.
A UBS report published in May entitled “Sustainable investing after Covid-19”, honed in on the social aspects of ESG.
“Corporate management of issues such as human rights, employee well-being, and community relations are under scrutiny, as issues that were considered luxuries in the past (e.g., flexible working models) have become critical business continuity mechanisms in the pandemic lock down and help to maintain public health, social justice, and economic stability.”
When it comes to climate change, a seminal issue in ESG investing, more than half of Americans have been at least “somewhat worried” in polls regularly conducted by the Center for Climate Change Communication dating back to November of 2008. That number has increased to two-thirds of the country in the last two polls, taken last November and this April.
A study conducted by Wells Fargo Wealth and Investment Management in March and April, well into the international shutdowns put in place to slow the spread of the contagious virus, found that when investors were presented with the full definition of sustainable investing, more than half had interest, including an outsize majority of women, 59%, and millennials, 64%. When presented with the likelihood of purchasing stocks or funds invested in companies that are aligned with their values, 71% were very or somewhat likely.
The death of George Floyd at the hands of Minneapolis Police Officer Derek Chauvin has put racial equality at the top of many investors’ minds. Wetherby Asset Management Chief Impact Officer Justina Lai said that ESG investing, much like protests and “frankly police brutality” are not new. However she said there has been an acceleration of momentum around interest in these types of investments of late.
The firm where Lai works and is a shareholder, Wetherby Asset Management, was founded in 1990 by Debra Wetherby, a 2019 Forbes/SHOOK Top Wealth Advisor and 2020 Forbes/SHOOK Top Women Wealth Advisor. At the time, the firm was ahead of the curve in its staunch commitment to impact investing. Since that time there has been steady growth in the popularity of this investment philosophy, interspersed with events that serve to further catalyze the trend.
Lai compares this moment to the aftermath of the 2008 financial crisis, when she also saw an increased awareness of impact investing.
“People lost a lot of money in 2008 and a lot of impact investments were stabilizing within investment portfolios so there was recognition that you can make investments in this way and actually outperform,” she says.
Driven by this increased investor interest, sustainable funds pulled in $45.6 billion in the first quarter while the overall fund universe saw $384.7 billion in outflows. At the end of March, this put global sustainable fund assets at $841 billion. While this was down 12% from an all-time high at the end of 2019, it was stronger than the 18% decline across all funds.
One of the big problems facing widespread ESG adoption is the lack of available options in most 401(k) retirement plans and even worse, the lack of education about the area of investing. According to a 2018 survey by the Plan Sponsor Council of America, only 2.9% of defined contribution plans included ESG funds and those funds held less than 1% of total plan assets.
According to Gallup and Wells Fargo only a quarter of investors surveyed in February of this year had heard “a lot” or a “fair amount” about sustainable investing funds, dwarfed by the 38% that had heard “only a little” and 37% that had heard “nothing.”
This level of information and awareness is at odds with an increasing level of interest from investors to include these considerations in the investment process. The same survey found that the most common reason investors gave for not using sustainable investing funds was not knowing enough about them, 71%, while 51% said they were not being offered by their financial advisor or 401k plan.
The wealth management industry by contrast is poised to seize the ESG opportunity. The Financial Planning Association, the Journal of Financial Planning and Janus Henderson found that advisors are increasingly taking up this effort, with 38% of advisors indicating they are currently using or recommending ESG funds, up from a static 26% in 2018 and 2019. Additionally, the survey found that 29% plan to increase their use and recommendation of ESG funds over the next 12 months, an uptick from 19% in 2019. It comes as no surprise that this is in reaction to client demand, with 40% answering that clients have asked about ESG funds in the past six months.
Another big problem for investors looking to invest with ESG in mind is understanding which funds and fund managers are actually practicing what they are preaching. In other words, all ESG funds are not created equal.
For example, Morningstar compiles its ESG data with the help of Sustainalytics. Until late last year that process took on a “best in class” approach to rankings. In practice, that meant companies were not being judged based on their sector, but rather evaluated against peers in their sector. With that in mind, the rating agency has recently innovated by replacing that more than four year old system which gives a certain amount of “globes” based on ESG score with a more holistic approach.
Even with those changes, there is much to be desired. Under this new system, the iShares MSCI USA ESG Select ETF, a product of the announcement earlier this year by BlackRock CEO Larry Fink that the firm will do more on sustainability, gets a top-level five globe rating. That fund, with its ESG label and strong rating from Morningstar has a 2% allocation to energy, just 0.7% below the average large cap ETF, including 0.71% invested in fossil fuel giant ConocoPhillips. On top of that, the fund is invested 3.64% in utilities, often an indication of more fossil fuel exposure.
“There is no designated regulator right now or regulatory body to set the standards,” says Wells Fargo Investment Institute head of global asset allocation strategy Tracie McMillion. “It is hard to get that oversight of products that are being offered under the ESG or sustainable investing moniker.”
At Wells Fargo, they have taken on that responsibility internally by looking at funds offered to clients and ranking them based on commitment to ESG or sustainable investing, according to McMillion.
“It’s still a bit of buyer beware when you’re looking for ESG funds,” she adds, saying that this is yet another opportunity for advisors to help clients find the right option.
“Responsible investing from the investors perspective involves competitive investment results first and foremost but what investors really want out of this is to be involved with companies, to invest in companies, that are appropriately addressing their exposure to environmental impact or societal impact. They want to do that and have competitive investment results also,” Calvert Research and Management president and CEO John Streur said during a recent SHOOKTalks webinar.
Streur added that the challenge for meeting that demand is in access to deep research on ESG factors that provides a significant understanding of how companies address the issues. On top of that, there is an increasing interest from investors for involvement with firms and companies that can drive positive change.
“It’s not enough to just avoid companies that are involved in unattractive businesses, it’s also not enough just to invest in companies with great brands, they want to be involved with investment management firms that can engage with companies, buy the good companies, work with them and drive improvement,” Streur added. “In a nutshell, competitive results, deep research and real corporate engagement that can make a difference.”
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