Socially responsible, sustainable, impact, ESG. These terms are often used interchangeably to describe investments that have a purpose beyond making a profit, but they shouldn’t be. They each have a different meaning, which can be confusing to advisors who want to attract and keep clients interested in such investments, including millennials.
Moreover, an increasing number of investors already own or plan to own such investments.
A TIAA survey of investors conducted earlier this year found that about one-third of investors say they currently own responsible investments and nearly 50% of those who don’t, plan to do so soon, with millennials sharply outpacing their elders on that account: 69% vs. 43%.
Given this backdrop, advisors could use a deeper understanding about what exactly these investments are.
Patrick Drum, a portfolio manager at Saturna Capital who has led the firm’s efforts to help financial advisors connect with clients on sustainability-related issues, has developed a visual representation of the differences between the various labels that describe investments with a social dimension, called The Sustainability Smile.
At one end is Traditional Finance, which looks strictly for positive investment returns without any consideration of the social dimension of an investment; at the other end is Philanthropic donations, which have no goal of making money.
In between is the continuum of investments that have a social dimension, with that consideration increasing as it moves from left to right and closer to Philanthropic.
Integrated Investing, for examples, prioritizes the profit motive but includes an overlay of secondary considerations such as environmental, social and governance (ESG).
“ESG is about financial performance but takes into consideration a broader set of due diligence questions on how environmental, social and governance facts drive or inhibit performance,” said Drum.
Financial performance is secondary. The preference is on how to optimize results, taking into account all other factors that are not just financial, said Drum.
Ethical/Advocacy tries to balance the profit motive with either the exclusion of certain investments such as tobacco or firearms that may also reflect an investor’s religious faith or the advocacy of certain shareholder positions.
The Carbon Divestment Campaign, which challenges carbon-based companies such as oil companies to transition toward more renewable energy sources, is an example of such advocacy, said Drum. In this category returns matter but there is “a certain level of ‘return forgiveness,” explained Drum.
Moving along the continuum is Thematic/Impact Investing, where financial performance takes a back seat to either the social theme of the investment, such as clean energy, or the social impact, which may not have a social theme. The priority is the measurable impact these investments have on society whether it be social, environmental or something else, said Drum.
A 2015 CFA Institute survey of over 1300 portfolio managers and research analysts, highlighted at a recent Schroders roundtable on ESG investing, found that ESG integration led all other social investment categories. Fifty-seven percent of respondents integrated ESG into their investment analysis and the decision-making process while just 23% included Thematic Investing in that process and 21% factored in Impact Investing.
Schroders itself includes ESG scoring in its “fundamental risk score” for all companies which also looks at leverage and country risk. It defines ESG broadly, to include ESG integration, thematic investing, governance and active ownership, impact investing, best-in-class responsible investments and screened investments.
Social investing “is becoming mainstream,” said Drum, “but it’s still experiencing what I call ‘the where Waldo effect.’ We’re talking about it but where is it? What does it mean? And there are different definitions.”
But now, noted Drum, there are the Morningstar globes, which could potentially become the standard to measure the social dimension of mutual funds and ETFs, just like the Morningstar stars have done for the performance of those funds.
These rankings are probably “the most powerful source of mainstreaming in this conversation and most advisors don’t want that conversation,” says Drum.
But they should. Not only will such conversations “help advisors understand how asset managers consider risk … and add a competitive edge to portfolios … but help them relate better to clients who want to have portfolios that not only earn profits but have the environmental or philanthropic bent that they desire,” said Drum.
“We talk a lot about fiduciary duty in this business,” said Schroder’s Jessica Ground, who oversees the integration of ESG into the firm’s investment processes. “We think about the concerns of our end clients. It is very clear they don’t want us to ignore how companies are interacting with the wider world.“
Millennials, not surprising, are leading the charge for incorporating social investing in their portfolios.
A 2016 U.S. Trust survey of high and ultra-high net worth Americans found that 93% of the millennials surveyed said social or environmental impact is important to their investment decisions – up from about 75% just two years earlier. Moreover the share of millennials focused on those issues was about double that for baby boomers and more senior investors. “Not a week goes by when I don’t hear about clients’ interests in these products,” said Heather Fischer, VP of ETF Platform Management at Charles Schwab. “There’s definitely been some toe dipping and there’s appetite for more.”
With that in mind, Schwab has just launched a list of socially conscious funds, based on Morningstar data, that will help its investors find socially responsible funds and ETFs.
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