Observations on the Latest Shifts in Sustainable Investing

After spearheading the Sustainable Investing initiative for a large wealth management wirehouse for several years, I found myself in transition this summer – and spent much of that time catching up with old and new friends across the ESG (environmental, social and governance) and impact investing ecosystem. This time has given me the opportunity to reflect on the state of the industry and the challenges it faces.

ESG investing is not a monolith

With the number of ESG investing conferences growing year after year, it is striking how frequently the impression can emerge that different investors are doing similar things. In reality, even if one leaves aside traditional exclusionary screening (stay out of alcohol, tobacco, firearms etc.) ESG investing consists of a variety of different approaches and styles. Wealth and asset management firms would be well advised to create more transparency around the investment approaches they take or promote.

For example, the vast majority of assets that are reported in industry trends reports such as US SIF’s feature some form of ESG integration, whereby ESG aspects are incorporated into the investment process. This happens with varying degrees of discipline and weight placed on ESG, is usually implemented firm wide or at least on multiple strategies at once, and is often accompanied by some increased focus on shareholder engagement with respect to ESG topics. This trend is being driven by the need to comply with commitments made by signatories to the U.N. Principles for Responsible Investment (PRI) and/or to satisfy demands from institutional asset owners.

This is quite distinct from more dedicated ESG strategies, that are often labeled and marketed as such. Examples in equities include, in particular, positively screened ESG strategies (minimum level of ESG performance required for inclusion); ESG-tilted strategies (which seek to increase the portfolio’s ESG score while controlling other characteristics); sustainability-themed strategies (often with minimum revenue required from solutions-oriented activities); or a strong focus on driving positive change through shareholder engagement (often combined with one of the strategies above). Making such distinctions matters for wealth and asset management firms.

How to talk to wealth management clients

While individual investors are growing fonder of ESG investing, they are usually still early on their learning curve and their financial advisors (FAs) are often not well-versed enough to avoid some confusion. There is a certain tension between the need for FAs to understand their clients’ needs and preferences with respect to sustainability and social impact and the lack of customization that arises from a monolithic perspective on ESG. Embracing some form of investment classification is a useful first step to ensure better communication with clients and better satisfaction in the long run.

What is also striking is that many individuals with a preference for sustainability do not find ESG integration strategies compelling, in contrast with dedicated ESG strategies. The reason is that an investment process that takes ESG aspects into account (along with traditional financial considerations) but without imposing any minimum standards is very likely to generate portfolios that include ESG laggards. This can be at odds with what individuals expect from an ESG portfolio.

Decision tree for asset management newbies

For asset management firms who are looking to develop their business strategy around ESG, two distinct decisions must be taken.

The first is whether to implement some for of ESG integration across the firm’s investment processes. This is increasingly demanded by a subset of institutional asset owners and also serves to fulfill commitments incurred by the PRI signatories.

The second is whether to launch dedicated ESG strategies, or in some cases reposition existing strategies. I would argue that this is necessary to capture a portion of the growing wealth management demand for ESG, as well as to serve the needs of the most dedicated institutional investors. Note that both approaches can be taken in parallel and are likely complementary in terms of the skills and resources involved.

United Nations SDGs: moving beyond mapping

2018 is clearly the year the investment community started truly embracing the UN’s Sustainable Development Goals (SDGs). I am thrilled by that move but would caution that this is just the beginning of a long journey until 2030. Today, investment managers are by and large merely mapping their investments to the 17 SDGs or, in some cases, to the 169 underlying targets.

Over time, some goals and targets will be better funded than others, and achievement gaps will diverge substantially across both indicators and countries. Any SDG-focused investment framework developed today should incorporate achievement gaps in order to remain relevant as 2030 approaches. Tools such as the SDSN or Bertelsmann SDG Dashboards (www.sdgindex.org) are a useful resource to this effect.

Image credit: Luke Fritz/Flickr