Sponsored by Parnassus Investments
Environmental, social and governance investing has moved into the mainstream. More and more asset managers are realizing that ESG issues are not only important to many of their clients, but also have become material for businesses. For example, intangibles like climate change have a significant impact on company financials today. As a result, ESG is now an important client retention and acquisition strategy for financial advisors who want to help clients express their values and more fully understand the risks and opportunities of potential investments.
Where Do I Start?
As ESG topics like climate change, waste, human rights and data security gain prominence, increasing numbers of clients are looking for ways to build wealth responsibly.
Women and millennials were early ESG adopters, but today a growing number of investors of all types are, at a minimum, aware of the risk-reduction benefits that they may reap by choosing investments that consider social and environmental issues.
Providing your clients with some ESG options that you feel confident about does not have to be overwhelming. Rather than overhauling an investment approach that has worked for you in the past, we recommend that you gradually add ESG choices to your existing investment offerings. Once you have acquired some basic knowledge about how to integrate ESG strategies into your practice, you can begin raising the subject with a few top clients who are friends and who you believe may be open to adding an allocation to ESG funds to their investment mix.
Takeaway: You can use ESG offerings to meet client demand while supporting client retention and growth.
Will Adding ESG Strategies Hurt Performance?
Studies confirm that there is no financial trade-off for choosing ESG funds. One recent large study measured the long-term performance of more than 10,000 ESG and traditional funds from 2004 through 2018 using Morningstar data. It concluded that returns for the traditional funds and ESG funds were statistically equal. On the other hand, downside risk was measurably lower for the ESG funds, and during a period of extreme volatility, the sustainable funds proved to be more stable. (Source: Morgan Stanley Institute for Sustainable Investing, “Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds,” 2019. Based on Morningstar data of 10,723 exchange-traded and open-ended mutual funds.)
Takeaway: You can help your clients stick to their investment plans by incorporating ESG choices that may help smooth volatility when the market is rocky.
Past performance does not guarantee future performance results.
There are no assurances the Fund’s investments objectives and ESG strategies will be successful. Mutual fund investing involves risks, including the potential for loss of principal.
Building Your ESG Knowledge
It isn’t difficult to learn the basic ESG concepts. However, the environment, social issues and corporate governance are all very broad topics, so we suggest you begin with a few selected issues. Focus on topics that are most relevant to companies’ performance over time, are important to investors and are likely to be heavily covered in the media.
Environmental
Environmental factors measure how well a company performs as a steward of the environment.
Climate change is a significant change in climate patterns, primarily due to higher levels of atmospheric carbon dioxide produced when fossil fuels are burned. These changes can result in extreme weather events that significantly impact businesses and communities, not to mention future generations.
A carbon footprint is the amount of carbon dioxide emitted, for example by a company in the process of doing business.
The waste stream is the full cycle of waste from product creation through disposal. Examples of waste include paper, plastics, metal, glass and hazardous material.
Social
Social factors are used to assess how well a company maximizes its relationships with its internal and external stakeholders.
Workplace issues include diversity and inclusion, compensation and benefits, employee health and safety, employee engagement and development, and supply chain labor practices.
Issues related to customers include product quality and safety, the benefits of a company's products and data security and privacy practices.
Examples of a company's relationship with community include the impact of its operations on the community, employee volunteering and philanthropy.
Governance
Governance encompasses the quality of a company’s management and board’s leadership. Examples include leadership structures, such as board independence; management compensation incentives; business ethics; and management turnover.
Where to Learn More About ESG Topics
To learn more about these and other ESG topics, take advantage of the many ESG-related resources available to you, for example:
- US SIF (The Forum for Sustainable and Responsible Investing) is a good source for ESG investing, including trends and asset flows.
- Morningstar provides standardized measurements of fund performance and risks, including sustainability and carbon ratings
- Ceres publishes excellent ESG thought leadership
- Insights sections are available on many financial firms' websites, including parnassus.com
Evaluating ESG Investments
ESG fund due diligence includes all the steps you would normally take to choose an investment, such as reviewing the fund's long-term performance, expenses, management team and brand. In addition, as you evaluate the ESG characteristics of various funds, you may want to assess each firm's level of experience with selecting ESG investments and how deeply ESG analysis influences the fund's investment process. An important consideration is whether the fund managers are seeking to make materials improvements in performance and/or risk results by evaluating companies' ESG records.
Once you've chosen some ESG investments, adding a step to your fund review process to monitor the socially responsible investments you recommend to clients is essential. Morningstar and MSCI are two sources for measuring a fund's ESG performance over time relative to other funds.
ESG Investment Categories
With so many ESG funds to choose from, how do you decide which investments are best for your clients? It can be helpful to categorize the choices and decide which ones fit best with your investment approach.
Exclusionary Screens
Potential investments, such as tobacco or fossil fuels, are excluded from investment.
Thematic Investing
A specific ESG issue is the focus of the investment, for example, microfinancing or alternative energy.
ESG Consideration
One or more ESG factors is added to the prospectuses of existing non-ESG funds that may then be considered in security selection, but ESG analysis does not necessarily influence investment decision-making in all cases.
ESG Integration
Broad-based ESG analysis is undertaken with the goals of identifying issues material to the investment outcome, managing risk and encouraging company progress on ESG issues.
Identifying Clients Who Are Interested
While some of your clients may ask about ESG investing, others may not be aware of the potential benefits. Some reasons that clients may be considering socially responsible investments include a desire to invest according to their values and encourage improvements in society as well as to avoid risks associated with portfolios that hold companies that perform poorly on ESG metrics.
We recommend that you look first at your best clients—those with the longest history and highest asset levels—as well as those with adult children that you may be able to bring into the conversation, thereby building a relationship with the next generation.
Step-by-Step Action Plan
1. Prepare for client questions using what you've learned about ESG topics. Let clients know you can offer them ESG investment choices at your client appreciation events, by including articles in your newsletter and during reviews of their portfolios.
2. Find out which ESG issues are important to your clients. You may want to mention current events to open the discussion. Or you might ask if they recently purchased an electric vehicle or solar panels. Has their employer been in the news for improving their ESG practices? Do they volunteer or make charitable donations?
3. As part of the discovery process, ask interested clients to complete an ESG interest questionnaire.
4. Use the questionnaire results and your research on specific funds to recommend a financial plan. You may want to suggest changes over time to gradually incorporate ESG strategies that resonate with each client in proportion with the level of their passion.
5. Track and report the performance and risk results of your clients' ESG funds. Share stories about individual companies in their portfolios that illustrate positive and/or improving ESG results.
Sample Elevator Pitch: Environmental, social and governance investing is being widely adopted now. I've done some research and think we can reflect some of the issues you care most about in your portfolio while seeking to maintain your performance and improve your risk exposures.
Visit the Parnassus website to learn more about how to build wealth for your clients and make a positive impact on society.
© 2020 Parnassus Investments. All rights reserved.
Mutual fund investing involves risk and loss of principal is possible.
The Parnassus Funds are underwritten and distributed by Parnassus Funds Distributor, LLC.
There are no assurances the Fund’s investments objectives and ESG strategies will be successful. Mutual fund investing involves risks, including the potential for loss of principal.
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