Environmental, Social, and Governance Investing Has Proven to Attract, Retain, and Serve the Needs of Today’s Investors. Many Investors See the Green Transition to a Low-carbon Economy as an Investment Opportunity.
Gone are the days when investors only cared about the bottom line. More and more investors are looking to align their investment objectives with their values. Larger investors seek to influence positive corporate behavior through their capital allocations. And a growing body of evidence indicates that companies that hold themselves to high environmental, social, and governance (ESG) standards deliver better financial performance in the long run. This confluence of trends has brought ESG investing to the forefront of many investment conversations. In one of the market’s most volatile and unpredictable periods, ESG is proving to be a bright spot. In fact, according to a report from MorningStar, new flows into ESG funds attracted a record $596.2 Billion through 2021. This is a 62% increase year-over-year from 2021. [1]
Surveys confirm that investors are increasingly interested in sustainability. One segment particularly attuned to ESG investing is the millennial generation—those born roughly between 1980 and 1995. A 2021 report from Harris Poll on behalf of CNBC Make It found that one-third of millennials often exclusively use investments that take ESG factors into account, compared with 19% of Gen Z, 16% of Gen X, and 2% of baby boomers.[2]
While sustainable or responsible investing is far from new, ESG investing today is more nuanced and requires much more research into the fine print of company initiatives. With no official standards, ESG factors are historically not included in financial analysis. However, investment managers are rapidly adopting ways to factor ESG into their decisions, not only to better align investors’ goals with their values but also to help overall investment performance.
Wealth managers are leveraging technology innovations to “tilt” portfolios towards sustainability, generate strong returns, and better differentiate their firms. As the great intergenerational wealth transfer takes place, and as millennials and women take on greater influence as decision-makers, ESG can potentially give wealth managers a competitive advantage.
Women-Led Companies Outperform
According to First Round Capital's portfolio, women-founded companies outperformed companies founded by men by 63%. Several studies show the US economy is increasingly reliant on the work and devotion of female entrepreneurs.[3] Women-led businesses outperform, and women in senior leadership contribute significantly to business success. Diversity is a strong predictor of economic value and a proven ESG factor.
Companies with women in top management positions produce more patents, are more reputable, and have higher retention rates. Diversity leads to different perspectives, which can drive greater innovation. As ThinkAdvisor put it, “Women in leadership, equal pay, board diversity, labor standards, community relations—these are all ESG issues, and they are all women’s issues. For advisors who are looking to expand their client base or be more inclusive of their current clients’ spouses, offering women the opportunity to invest in things they care about can be a differentiator. Women investors want to invest in sustainable companies without compromising returns; part of being sustainable is investing in women. One could argue that it’s a triple bottom line.”*
The rise of ESG is due in large part to its ability to deliver long-term investment returns, but also its role in reducing risk. Today, corporations face unprecedented risk related to climate concerns and environmental impact, use of water and other natural resources, worker treatment throughout the supply chain, and the safety and usefulness of products. Many investors want clarity to assess and measure companies’ progress in addressing these risks.
The widespread growth of consensus around sustainability concerns has propelled ESG investing. Now, even the world’s largest asset manager, Blackrock, calls for ESG in reporting and will make ESG a key criterion in any new company in which it invests.
Studies show that many millennials prioritize social responsibility in their daily lives, whether through the products they purchase or the organizations they support. It’s no surprise that as they accumulate their wealth, they want their investment portfolios to mirror these passions. Over the past year, a broad consensus on the need to address climate risk in investment portfolios has emerged. More investors see the green transition to a low-carbon economy as an investment opportunity. America’s 72 million millennials represented $600 billion in annual spending, growing approximately $1.4 trillion in disposable income in 2020.[4] Not only will they continue to power the demand for ESG investing, but millennials are the key to the future of wealth management, as they will inherit $30 trillion over the next several decades.
According to a study by EY, when assets change generations, the previous generation’s advisors typically lose 70% to 80% of those assets.[5] Consequently, wealth managers who supply millennials with value-based investment options will be well-positioned to retain beneficiary millennial clients, as well as to attract new, like-minded investors. As wealth managers seek to capitalize on the growing demand for ESG investment solutions, there are several perspectives and disciplines they should consider incorporating into their investment processes. Chief among them:
Recognition of ESG as alpha seeking. From the information technology sector, top quintile ESG Improvers outperformed bottom quintile decliners by 10.4% annualized from 2010-2020. ESG integration is becoming well-known with some of the world's largest institutions allocating capital to dedicated ESG strategies in the search for alpha.
America’s 72 million millennials represented $600 billion in annual spending, growing approximately $1.4 trillion in disposable income in 2020.
ESG screens. Wealth managers may offer negative screening through managed accounts—a process that excludes certain categories of stocks from a portfolio. A range of criteria can be used to screen funds and managed accounts, including traditional SRI screens such as alcohol and tobacco. Business ethics screens including such issues as child labor or animal testing are also gaining popularity.
Transparency and reporting. Investors want more transparency on the ESG characteristics of their investments—they want to “know what they own.” Not only are investors asking about ESG in their portfolios, but they also want to understand the benefits of ESG. Technology platforms can now provide detailed reporting and analysis of ESG factors. Regulators are also questioning ESG labeling and demanding detailed reporting to prevent “greenwashing,” making detailed analytics more valuable than ever.
Direct indexing. Direct indexing is the construction of a custom investment portfolio that mirrors the composition of an index. Through advanced rebalancing technology, advisors can build ESG tilts into the portfolios they provide to clients. Portfolios can be designed for single ESG factors (for example, women in leadership), multiple factors (women plus environmental and no child labor), or everything in between.
While meeting investor demand and potentially delivering superior returns, firms that adopt effective ESG practices stand to reap additional business benefits. ESG investing gives advisors a new marketing message, differentiating the firm to investors looking to align their investments with their values. It can also open an avenue of growth with priority clients—millennial and women investors—who trust that advisor to take their investments into the future. ESG can further help advisors rationalize fees by demonstrating significant value relative to less costly competitors or free robo services. Internally, firms can scale and increase productivity with portfolio analytic technology solutions that make it easy to compare, contrast, and construct ESG portfolios.
As environmental, social, and governance investing continues to take root, wealth managers must adapt to attract, retain, and serve today’s investors. An ESG offering can help align clients’ portfolios with their values while contributing to overall sustainability for future generations—a win, win, win for investors, advisors, and the environment.
Technology is playing a major role in helping advisors navigate the ESG landscape. A number of research firms have emerged in recent years with solutions for scoring and ranking companies on ESG attributes. Technology can also provide a platform for accessing ESG solutions and streamlining the research process. It's time to start using technology to take conversations to the next level and with personalization, advisors can understand people's intent as well as allocate which digital solutions can help move these conversations forward. Act Analytics, a leading technology platform for ESG investing analytics, they are also a Retirement Group integration partner. Advisors can download portfolios from The Retirement Group into a comprehensive ESG analytical framework, enabling them to compare and contrast portfolios with benchmarks from more than 200 ESG factors across 100,000 mutual funds and ETFs, and more than 20,000 publicly traded securities. These analyses help advisors generate trade opportunities and report on both individual and overall ESG scores.
In addition, advisors at The Retirement Group integrate financial planning and risk analytics providers to develop plans that reflect their clients’ ESG preferences and interests and demonstrate to clients the impact of ESG in their portfolios. To learn more about the Retirement Group Wealth Platform and its integration network, please call 1-800-900-5867, email info@theretirementgroup.com, or visit theretirementgroup.com.
ESG investing gives advisors a new marketing message, differentiating the firm to investors looking to align their investments with their values.
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Baldridge, Rebecca. "Beat Funs At Their Own Game With Direct Indexing." Forbes, April 15, 2021
Cher, Audrey. "Sustainable funds are outperforming their peers during the pandemic, BNP Paribas says." CNBC
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