Financial advisors are warming up to socially responsible investing. At least a little.
There has been an uptick in the number of advisors embracing portfolios that screen for environmental, social and governance (ESG) factors, according to the latest survey on social investing by Nuveen. Thirty-six percent of advisors say they offer the portfolios to clients, and 51% say they discuss the idea as a potential investment option. That’s up from 41% in 2017. And only 17% of advisors “felt negative” about ESG compared with 28% who said the same thing in 2017. Forty percent say they are indifferent to the trend. Over half of advisors felt that way in 2017.
“We’re really beginning to see the tide turn regarding the adoption of responsible investing,” says Megan Fielding, senior director of responsible investing at Nuveen. “Advisors and their clients increasingly recognize that this approach can have a demonstrable, positive influence on long-term investment performance and also serve to mitigate or manage risks.”
That’s the glass-half-full viewpoint. Paul Ellis looks at it differently: “There really has not been much progress in the advisor community, or attitude change, toward sustainable and impact investing.” Ellis is a sustainable finance consultant and a former certified financial planner who has done a good deal of education work in the advisor community on ESG investing.
“For the most part, we’re talking about people of my generation—the ‘stale, male and pale advisor community,’ as a friend put it recently,” Ellis says.
“It’s predominantly male, and people who have been in the industry at least 10 years. They are established, with successful practices and good relationships with clients—everything an advisor wants,” he adds. “They are very secure in their habits, their approach to practice management and the investment strategies that they used to build their practices in the first place.”
But will those strategies be the right ones in the future? Asset flows suggest they are not. ESG funds rely on screening securities for their exposure to nonfinancial factors like a firm’s environmental impact, its governance policies, or how it treats employees or monitors its supply chains, among other things. Funds either tilt away from securities that an investor believes have a high risk associated with those factors, or tilt toward those that an investor believes will make a positive impact.
Last year, ESG funds attracted record net flows despite an overall tough year for mutual funds, according to Morningstar. ESG funds attracted nearly $5.5 billion in net new money, to $161 billion. Interest is strongest among millennial investors—in other words, the future of the business.
Retirement plans are another story. Plan sponsors are obligated to provide investment options in the best interest of participants, and the argument over whether ESG investors are sacrificing performance has not been settled to everyone’s satisfaction.
Shifting guidance from the U.S. Department of Labor on where ESG fits from a fiduciary perspective has largely kept these options out of workplace retirement plans. An April 2018 statement from the SEC meant to clarify its position just made for more confusion among plan sponsors. “It’s murky right now,” says Fielding.
But Fielding thinks it is still early days for educating advisors on ESG, and even earlier for educating plan sponsors.
“Advisors focused on retirement still need to be educated that they don’t need to give up performance to invest in this way,” she says. “There also are challenges with record-keepers in terms of what it can take to add a new menu choice.”
A case is building that it’s possible to have your cake and eat it too. Morningstar issued a report recently comparing 56 of its ESG indexes with their non-ESG equivalents. The firm found that 41 outperformed their non-ESG-screened equivalents, although that finding had a distinct international tilt. That’s because some star U.S. stocks—including Apple, Amazon and Facebook—don’t enjoy strong ESG ratings.
Jon Hale, head of sustainability research at Morningstar, says he hears more advisors are fielding questions from clients about ESG, but they don’t always know how to respond. “They used to give it the wave-off, but you really don’t want to do that. More advisors are realizing that they need to have answers to these questions—and that if they do not they could lose the client, because it will call into question a lot of things about the advisor. The clients are thinking, ‘I’m hearing every day about the climate crisis, but you’re telling me not to worry about it?’”
Hale argues that ESG offers a way to build a more holistic approach to investing. “Advisors are people too, and they want to make their work more meaningful. And if you really care about your clients’ goals and values, you build trust by focusing on what concerns them.”
An early ESG innovator in the retirement plan market is Natixis Investment Managers, which launched an ESG target date fund series in 2017. The series remains small, with $40 million in assets across 10 funds and 50 plans signed up. Most are small or medium-sized plans that themselves are in sustainable industries such as solar energy, says Ed Farrington, head of retirement for the firm.
“We’re seeing more adoption than we were two years ago, but there have been some headwinds and confusion that have slowed down what would have been more rapid development,” he says, referencing the DOL guidance problems.
The main challenge now, he believes, is educating advisors and plan sponsors on how ESG can “align very well with fiduciary responsibilities,” he adds.
The Natixis TDFs are off to a good start in this respect. For example, the Natixis Sustainable Future 2035 Fund was in the 18th percentile of all TDFs measured by Morningstar last year.
And strong demand from millennial plan participants—who soon will be a majority of the U.S. workforce—makes ESG an inevitability in the future of workplace plans, he argues. “Most of them say they would start investing or increase their rate of investment if there were more sustainable options in their plans,” he says.
Farrington agrees that advisors have been skeptical. “For so many years, they were told that there was a trade-off between responsible investing and performance, and they were always shown negative screening products, so they have been reluctant to look at it again.”
But as advisors look for new ways to provide value to clients beyond asset allocation, those who are conversant in ESG will have an edge, he thinks.
For advisors who don’t want to get on the bandwagon themselves, Ellis has a suggestion. “If you’re not going to focus on this yourself, make sure you have at least one younger advisor in your practice who does. You can read the same studies I do: All the women who control assets and the millennials are saying that if they can’t find a firm that offers this, they’ll go somewhere that does.”
