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ESG: Are You Missing The Forest For The Trees?

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Misconceptions and miscommunication may be preventing skeptics from seeing the bigger picture.

Environmental, social, and governance (ESG) investing — or “sustainable investing” — continues to gain awareness, acceptance, and assets. So why does skepticism still run so deep among many advisors? Perhaps part of the answer lies in a lack of clarity.

We invited Kiley Miller, head of ESG product development and management for Envestnet PMC, to share her views with The Flexible Advisor. Kiley spent more than three years at Sustainalytics, and is currently on the team that runs sustainableme.today —a source of practical information about integrating sustainability in all aspects of life. 

KEY TAKEAWAYS

  • Sustainable investing includes a range of interconnected approaches addressing environmental health, social equity, and long-term economic performance. 

  • Advisors might dismiss ESG if they fail to understand the important distinctions between ESG approaches. 

  • Advisors who discount the potential merits of sustainable investing may miss out on notable value propositions it can bring to their practice.

‘ESG aware’ vs. ‘ESG focus’

“We need to better communicate the intention of ESG information,” said Miller. “Sustainable investing encompasses a range of approaches that recognize and address the interconnectedness between environmental health, social equity, and long-term economic performance.”

These approaches fall into three primary categories:

  1. ESG integration, which is addressing ESG related risks and opportunities in the investment process. 

    Miller sees the asset management industry well on its way to mainstreaming ESG integration. “It's about measuring and managing financial and material risks, which is a fiduciary obligation.”
  2. Values alignment, which is negative screening.
  3. Impact, which is specifically targeting positive impact alongside a financial return.

These strategies apply a much more focused approach, with ESG information being the central tenet of the investment philosophy and decisions. 

While several approaches fall under the “ESG” umbrella, some advisors might dismiss ESG out-of-hand when they fail to understand the important distinctions between them.  

No wonder we’re confused

Inconsistent messaging is a significant challenge across the industry. As Miller says: “The wide range of terminology and taxonomies for sustainable investment approaches is intimidating. We need better transparency, and better accountability, from managers on their approach.”  She does note that the SEC is working on proposed requirements for investment managers on ESG claims and related disclosures. “Hopefully that will entail more standardized language and a clear taxonomy for managers to describe their approach.” 

Another unfortunate source of misunderstanding: oversimplification. “I don't like the whole notion of ‘doing well and doing good’,” Miller said. “Everyone has their own interpretation and definition of ‘doing good.’ Every investor has their own set of values and belief systems. A blanket statement that categorically simplifies this space, oversimplifies this space. And I think that as an industry, we need to be better.”

“Sustainable investing encompasses a wide range of investment approaches. You can't really bucket them all together. You have to find the right approach for the client.”

--Kiley Miller, Director of ESG Investment Solutions, Envestnet

Common objections, simple answers

We asked Miller how she addresses the three most common objections she hears from advisors. 

  1. My clients aren't asking about this.
    “Investors don't come to their advisor asking for a 60/40 dividend portfolio. They come with their situation and experience, and the advisor gives advice. Just because someone hasn't asked about sustainable investment options doesn't mean that they're not interested” (Note: A November 2021 FlexShares survey of high-net-worth investors found that over 70% of respondents are interested or very interested in sustainable investing, yet less than 50% of them ever had their advisor bring up the topic.)
  2. I don't want to give up performance.
    “Sustainable investing encompasses a wide range of investment approaches. You can't really bucket them all together. You have to find the right approach for the client. And that approach does not necessarily have to be concessionary.” 
  3. I don't trust that managers aren’t greenwashing.
    “This goes back to understanding the different approaches. Look under the hood for transparency on the approach, rely on sound diligence of that approach, and know what the right fit for the client would be.”

The sustainable value-add

Miller suggests that advisors who discount the potential merits of sustainable investing may also be missing a notable value proposition it can bring to their practice. “We're seeing millennials increasingly turn towards self-directed investment tools. They're more comfortable with technology and they've gathered assets in the context of a 10-year bull market. They aren't afraid to take risks. But we know that this cohort would benefit from a more holistic financial plan. One way to engage is with sustainable investing.”

Sustainable investing also adds a notable dimension in personalized advice. Miller notes, “As investor needs evolve toward more customized investment approaches, advisors should really arm themselves with a deep understanding of who their clients are, what they stand for and how they want to really put their money to work in the world. That results in higher retention. Advice these days is increasingly commoditized, and no two clients have the same values. So that personalization can really act as a differentiator.”

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The bottom line: “Sustainable investing offers another opportunity for advisors to have deeper, more meaningful relationships with their clients.”

 

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Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. An ESG investment methodology that includes and excludes issuers and assigns weights to issuers by applying non-financial factors, such as ESG factors, such ESG investment methodology may underperform the broader equity market or other investment products that do or do not use ESG investment criteria. An ESG investment methodology will influence exposure to certain companies and sectors.

Currently, there is a lack of common industry standards relating to the development and application of ESG criteria, which may make it difficult to compare an ESG investment methodology with the investment strategies of other investment products or funds that integrate certain ESG criteria. The subjective value that investors may assign to certain types of ESG characteristics may differ substantially from that of an ESG investment methodology or a data provider.

Not all FlexShares ETFs have an ESG focus. For more information on which FlexShares ETFs have an ESG focus, please visit flexshares.com

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