“Why can’t my investment portfolio reflect my personal values?” We’re increasingly hearing that question from clients who want to pursue sustainable investment strategies that align their personal values with their investments. According to Morningstar, assets in socially screened portfolios now exceed $6 trillion, up from $639 billion in 1995. Demand for sustainable investments seems particularly important to the millennials that represent the next generation of investors for advisors. A Morgan Stanley survey of individual investors highlights this coming demand, as 71% of respondents and 84% of millennial investors expressed interest in sustainable investing.
Some investors pursue alignment with their personal values by excluding individual companies or economic sectors, others through inclusionary and exclusionary criteria at an individual company level. Sustainable investing comes in many forms, covering distinct but not always clearly defined categories including sustainable investing, socially responsible investing (SRI), impact investing and environmental, social and governance investing (ESG).
We expect sustainable investing to enter the mainstream in coming years, making tomorrow’s approaches very different than the approaches that thrived in recent years.
Here are five trends to watch.
Trend 1: “I Want My SRI” Clients will want their personal preferences reflected in their portfolios.
The band Dire Straits sang “I want my MTV,” in their hit 1980s song “Money for Nothing.” Tomorrow’s investors may sing a different tune, favoring investments with a social impact while avoiding those considered to have a negative impact.
However, sustainable investing means different things to different people. Some investors prioritize environmental considerations, others prioritize social issues such as child labor or governance issues such as more diversity on corporate boards. Environmentally focused investors may not have uniform environmental priorities.
Some clients favor fossil-fuel-free strategies that divest completely from oil, gas and coal companies as well as energy services companies that support the oil, gas and coal industries; others favor low carbon strategies that avoid companies with the heaviest carbon footprint. There are some similarities between the approaches, but also some profound differences!
We expect investors to demand options more explicitly aligned with their personal preferences – creating much more in the way of personal choice. In much the same way that cable television now provides entertainment choices tailored to a variety of diverse interests, the sustainable investment field will see an expansion of options in mutual funds, ETFs, indexes, and customized separately managed accounts.
Trend 2: “Show Me the Money” The flow of money into the industry will change the established order.
The 1996 movie Jerry Maguire originated this well-known quote, used by many in subsequent years. Money flows into sustainable investing strategies will change the nature of the industry. Pioneering sustainable investment firms such as Calvert, Parnassus, and PaxWorld were friendly competitors who shared foundational beliefs and often collaborated on issues of mutual interest. Most major investment firms are offering, or are considering offering, sustainable investment strategies. BlackRock created a dedicated division focused on sustainable investing, Goldman Sachs acquired an ESG-focused firm, and Merrill Lynch and UBS are among the retail broker-dealers that have launched or plan on launching responsible investment platforms. New entrants will undoubtedly change the competitive environment, with both positive and negative implications for clients.
Trend 3: “Crazy Eddie’s Prices Are Insane” Price competition is coming!
I grew up in New York, and remember watching commercials with my grandfather and uncle for the “Crazy Eddie” chain of retail electronics stores. Expenses can be silent killers, eroding mutual fund returns for often unsuspecting investors. Investing in actively managed funds can be an expensive proposition, as expense ratios for actively managed sustainable funds average approximately 1.2%, according to an Advisor Partners study.
Crazy Eddie’s legacy is alive in the investment world, as ETFs and robo-advisors are creating what appears to be a “race to the bottom” in fees for traditional investment products. With the entry of new competition, I expect to see fee-compression pressures in coming years for sustainable investment strategies.
Burton Malkiel’s seminal book on investing, A Random Walk Down Wall Street, argues that one can’t consistently outperform the markets. Proponents for sustainable investing have argued, with some degree of academic research support, that ESG factors have predictive content, and that companies with higher ESG scores may outperform those with low ESG scores. However, the entry of additional investors that combine financial with ESG analysis may dilute whatever investment advantages may be provided by ESG considerations.
The CEO of a leading responsible investment firm was recently quoted in The Wall Street Journal as saying “If you invest sustainably, you’ve got just as good a chance of beating the market or not.” That statement may miss the point for the next generation of investors, who I suspect may be less than excited about spending upwards of 1% in expenses per year to invest in strategies that have a 50/50 chance of outperforming. Followers of index-fund proponents such as Malkiel, John Bogle and Charley Ellis would argue that high fees and taxes undercut returns, and that index-based solutions will have a performance advantage over most actively-managed responsible investment strategies.
Trend 5: “Papa Don't Preach” Our children and grandchildren have different social priorities.
Another song from the early days of MTV, Madonna’s “Papa Don’t Preach”is a reminder that personal values may vary dramatically among generations. Nuclear power, the aftermath of the Vietnam War, and polluted rust belt communities framed my generation’s perspective about social issues. My children know little about protests at the Seabrook nuclear power plant or about the Love Canal, but they are very familiar with the fossil fuel divestment movement, Occupy Wall Street, same sex marriage, and LGBT equality issues. Y ounger investors often give me a blank look or protest when I mention the faith-based exclusions of alcohol, gambling and adult entertainment that are found in many of the largest socially screened mutual funds. Different generations may have some very different social priorities, with those differences implying a need for fresh approaches to the social screening aspect of sustainable investing.
What We Tell Clients
In our work with clients, we offer some high-level thoughts as a starting point for those who have both social and financial objectives:
- Define what you want to accomplish: Defining the investment objective, social considerations and time horizon are a critical step in the process. Determining your core values, and how to align those values with your investment portfolio requires some introspection and consultation with your advisor.
- Decide whether you want absolute or directional alignment with your values: There are a wide variety of responsible investing mutual funds and ETFs. Mutual funds and ETFs are “easy,” in that it’s a simple process to buy and sell them. However, it’s unlikely that you’ll find a mutual fund or ETF that is 100% aligned with your personal values. If directional alignment is enough, a mutual fund or ETF may satisfy your needs. If absolute alignment is important, a separately managed account may be more suitable. However, absolute alignment comes with a cost, potentially in higher fees, complexity or personal involvement in the design process.
- Understand the investment implications: There may be financial tradeoffs associated with a responsible investing strategy. Work with your advisor to understand the investment risks associated with different values-driven investment strategies, so that you’re fully informed about the environments in which the strategy will thrive or struggle.
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Historical performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss of income and/or principal to the investor. Nothing in this communication is intended to be or should be construed as individualized investment advice.