The number of financial advisors investing a portion of assets according to environmental, social and governance criteria has increased substantially.
Two years ago, 41% of top advisors polled by Ignites Research used ESG products or ESG ratings (or both). This year, that figure soared to 69% of advisors.
There are two ways FAs can approach ESG investing. One is to use a mutual fund, ETF or separately managed account with an ESG-focused objective. The other way is to assess all investment products (not just those oriented to sustainability) on ESG criteria relative to category peers, using ESG ratings from providers such as Sustainalytics (which powers Morningstar’s sustainability ratings), MSCI, FTSE Russell or others.
ESG ratings are less popular among advisors than ESG products. Around 18% of advisors use both ESG-specific products and ESG ratings, but 39% use only ESG products (and only 12% use only ESG ratings).
Scroll down to view video on how wirehouses — Bank of America’s Merrill Lynch, Wells Fargo, UBS, and Morgan Stanley — are busy competing to burnish their images as institutions with the most awareness of ESG and impact investing.
Among the reasons the use of ESG products is more popular than the use of ESG ratings is that there are more asset managers marketing specific ESG products than there are ESG ratings providers touting their systems. And, advisors appear more comfortable using some ESG funds or ETFs in portfolios than trying to apply some sort of ESG ratings or screen across portfolios because the latter option seems like a bigger commitment to an approach that is still nascent.
Sean Miranda, an advisor at Baird in Louisville, Ky., says not many of his clients pull the trigger on ESG investments once they review the performance and expenses, but he does have a “handful” of clients who wish to own them.
“As a CFP Professional, there are a lot of restrictions we create a plan around, like tax and legal investment restrictions,” says Miranda. “Ethical restrictions are not as popular, but they are certainly is a growing topic.”
The sustainability/ESG ratings business has some momentum, with the spreading influence of providers such as Sustainalytics and ISS (and Lipper’s plan to enter the field in 2020), and the growth of niche providers such as EcoVadis, which focuses on debt markets. But ESG products have even more momentum than ratings from the perspective of advisors. Earlier this year Morningstar estimated that the number of mutual funds and ETFs specifically packaged as ESG products rose by half in 2018, from 235 to 352 at year-end; that included 80 products entering the category by being relabeled as ESG.
There are now more than 100 asset managers with mutual funds or ETFs that are defined as “socially responsible” by Morningstar — enough that some are viewed as better than others at ESG.
Ben Smith is the founder of Whitefish Bay Wis.-based Cove Financial Planning, a fee-only fiduciary financial planning and investment management firm specializing in SRI. He says a “fair number” of his clients have requested the incorporation of ESG investments in their portfolio.
“Being that I specialize in SRI/ESG, I’ve found that some people reach out to me primarily because of this specialty in my practice,” says Smith.
He sees “quite a lot of client demand” for ESG products — specifically among younger investors.
“I find that some clients are learning, through their own research, about how SRI and ESG works. And the reality is that you really do not need to sacrifice investment performance to invest responsibly,” Smith says.
Smith characterizes himself as a “huge believer” in ESG investing.
"I invest in these products in my own personal portfolio,” Smith says. “I think that if research shows that investors can invest their money responsibly while also achieving the investment success needed to reach their financial goals, then why not do both?”
In his estimation, the various ratings provided to advisors are a “good start” — helpful for those who really understand how the ratings are implemented.
“Because the different firms rating these companies/investments do so with different criteria, it can be difficult to match apples-to-apples when looking across different ratings firms,” Smith says. “That being said, it’s critical to understand how specific companies and investments earned the rating they received.”
John McGlothlin of Southwest Retirement Consultants in Austin, Texas has recently assembled his firm’s first all-ESG portfolio for a new client — a couple in their 40s.
“That fact contradicts a common assumption that the push for ESG will come only from younger investors,” says McGlothlin. “We’ve had had clients in their 30s, 40s, and high 50s all ask about ESG options.”
In terms of ESG products, McGlothlin sees quantity outranking quality among today’s mutual funds and ETFs.
“To me a quality fund will integrate ESG criteria while keeping costs at or below average and performance on par if not above category averages,” says McGlothlin, adding for him few extant funds meet those criteria. “ESG advocates often loudly proclaim that ESG funds need not lag in performance, and I think that’s true — but only a few firms and funds have managed to thread that needle.”
Ignites Research surveyed 895 advisors from the Financial Times’ lists of top financial advisors — the FT 300 top RIAs, FT 400 top broker-dealers and FT 401 top retirement advisors — asking them their views and usage of model portfolios.
Additional reporting by FA-IQ staff.