When a client asks for investments that score high on environmental, social and governance (ESG) metrics, how can you align them with your client’s values, such as addressing climate change and social and economic inequities?
“When I bring on new clients, I ask the question: Is it important to have certain personal values reflected in your investments, or are there industries in which you definitely want or don’t want to invest,” says John McGlothin, III, the president and chief compliance officer of Southwest Retirement Advisors, in Austin, Texas. “Half the time [the answer] is no and half the time they say, why do you ask? And we take the conversation from there. “
McGlothin favors actively managed funds and says sustainable investing favors companies that are adjusting for material risks that could affect their operations and position them well for now and the future. However, he stresses that he holds ESG funds to the same standards as any other funds – favoring expense ratios below average and performance above average for their fund asset category.
He tells clients they will pay a little more for ESG funds to cover the costs, but he expects the fund will hopefully perform above average in its category.”
McGlothin says the returns are not necessarily higher but better on a risk-adjusted basis – “taking a little less risk to get comfortable returns.” That’s easier to justify for older clients rather than younger ones who have less need to lower their investment risk given their longer-term time horizon.
Unlike McGlothin, Heath Biller, a financial advisor at Fiduciary Financial Advisors in Grand Rapids, Michigan, doesn’t encourage sustainable investments but won’t oppose them if clients want them.
“I don’t want to filter out any companies that could be performing really well.” If a client asks about ESG, Biller quotes Vanguard founder John Bogle: "Don't look for the needle in the haystack. Just buy the haystack.”
He explains the screening criteria used by ESG funds could result in removing some of the best-performing companies, which is exactly what happened in 2022. Oil prices doubled in the first half of the year and ESG-focused funds, which had far less exposure to the energy sector than other funds, underperformed.
Biller advises clients to stick with traditional index fund investing and donate earnings in their after-tax accounts to the causes they support. “This option allows them the benefit of donating directly to the causes that are important to them. Additionally, they can usually get a tax deduction.”
Scott Bishop, partner and managing director of Presidio Wealth Partners in Houston, is also no fan of ESG investing. “People can invest with their hearts… that is their right, [but] it would be folly to have that be the highest priority in allocating capital.”
ESG investing does have its critics. Fourteen states, including Florida, Louisiana and North Carolina, passed laws last year that restrict the use of ESG factors in state pension fund investments and many of those same states target financial institutions that use an ESG approach to investing, according to a November 2023 Harvard Law School Forum on Corporate Governance.
But Bishop and Biller’s approach to sustainable investing is typical of many financial advisors, according to Jeff Gitterman, founder of Gitterman Wealth Management in Edison, NJ. Gitterman Wealth Management specializes in Unified Managed Accounts (UMAs) that focus on addressing climate change and consist of separately managed accounts from outside money managers that hold individual stocks and bonds.
“The interest level [for sustainable investing] is still very low among advisors,” says Gitterman. “But when they get a call from a client that they’re leaving because another advisor offered them ESG options, then most advisors get interested… We’re still in the early stages.”
Gitterman, whose firm serves individual clients and offers a sustainable investment solution for advisors, says there’s a great need for education about sustainable investing for both advisors and individual investors.
Advisors need to feel confident about their knowledge of sustainable investing before offering such portfolios to clients. Individual clients need to understand what sustainable portfolios comprise – companies that treat their employees and the community well, don’t pollute the environment and have good corporate governance. “When you say it that way, the clients say, ‘Oh, that’s not what I thought it was,’” Gitterman says.
Whether investing in individual stocks, bonds, mutual funds or ETFs, financial advisors should consider familiarizing themselves with sustainable investing principles and practices for various reasons.
Many asset managers already incorporate sustainable investing principles in their analysis of companies and portfolio construction even if their funds or SMAs or UMAs aren’t labeled as such.
Existing and potential clients, especially millennials and Gen-Xers, may well prefer the strategy for all or part of their portfolio and they may not engage you if you can’t accompany that preference. Even if you oppose the approach, it would be helpful to know enough about it to discuss those reasons with clients.
Understanding sustainable investing will help you differentiate between funds that aren’t thoroughly ESG and those that are truly choosing assets based on a comprehensive analysis of material risks that can affect their valuations.
If done right, sustainable investing directs capital to companies that can prosper over time despite long-term challenges posed by the economy, the environment and other major factors.
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