Investment advisors who don’t offer environmental, social and governance investments in their practice might miss out on today’s largest generational trend in money management.
Not only are experts seeing a surge of interest in ESG investment by millennials and women – two key demographics who either are currently controlling or about to control immense wealth as the transfer of assets occurs or they grow more enmeshed in investment – companies have incorporated ESG into their business practices due to investor demand. “Get with the program” was the warning by two experts to RIAs attending a Morningstar Investment Conference session on how to incorporate sustainable practices into an advisory business.
And the facts bear out the warning given by Paul Ellis of Paul Ellis Consulting and Jeffrey Gitterman, co-founding partner of Gitterman Wealth Management, both who manage or consult on sustainable practices. Gitterman says the data on ESG has become more material and is seen regularly in the daily news. “In 1985, 80% of a company’s stock performance was based on financial metrics. Today, 80% of a company’s stock performance is based on mostly brand identity and customer loyalty, and the only tools that allow you to screen for predictability around those issues are ESG,” he said.
In addition, 20% of all Fortune 500 companies are held by signatories of the Sustainable Accounting Standards Board, which Ellis said was basically the FASB for ESG data. And most of those companies have “at least two climate scientists on their payroll right now because many won’t entertain long-term projects without conferring with climatologists,” Gitterman said. Even insurance companies have started denying long-term bonds along coastal real estate projects, so ESG already is changing business behavior, he said.
Ellis, who began his sustainable practice while at Merrill Lynch in the 1980s, which he eventually sold, said ESG has “more acknowledgement today by large asset managers as well as advisor firms and is a significant part of how we do business.” Gitterman agreed, pointing out a recent shareholder letter sent by Larry Fink of Blackrock who wrote that if a board of directors isn’t integrating the climate change threat into its behavior, get a new board of directors.
Putting Into Practice
Gitterman said they found that West Coast clients were “deeply interested in the value side, while in New York City, they were more skeptical [returns would be as good as non-ESG].” But using data now available they are able to show returns justify the move to ESG investments. In fact, last year they transitioned $40 million of client money into ESG portfolios, he said.
Ellis said to get a feel of his clients, he would take a simple survey listing all ESG metrics, which not only helped him direct client portfolios, but also enabled him to speak with asset managers on what his clients were interested in, for example 10% cared about carbon dioxide pollution, while another 15% were focused on water issues.
He said another trend he’s seeing is in adult children of baby boomer clients. “About 80% said if an advisor isn’t using ESG metrics in portfolio performance valuation, they would leave [the firm when they inherit their parents’ assets],” he said. Further, those who have or inherit legacy stock positions are using those to become more activist shareholders.
“We look at ESG as a base of a pyramid, then layer values or SRI, then [measure] impact at top,” Gitterman said. “We’re not screening out negative companies, but using good data more readily available to make stock decisions. Above that we layer values based on discussions with client, such as [not wanting to invest in] fossil fuel companies. Impact means how companies are held to specific standards.”
He adds, “ESG is a trend, not a fad. Today, information is immediate and affects stock price immediately, for example, compare when the Exxon Valdez happened [in 1989], there was no impact on stock price, to today a rabbit dying on [United Airlines], the stock price was affected. It’s a whole new world. How we measure performance, how we measure companies, who we can relate to, is completely turned on its head. Look at Tesla; it has a larger market cap than GM or Ford, but its percentage of all auto sales is .2%. What’s material in stock valuation today is major.”
So when evaluating ESG stocks, they ask whether these companies have a sustainable model, do they have a board that’s thoughtful about the environment; do they care about employees, how many employee lawsuits have been filed? “These are questions we feel are critical for companies to stay in business,” Gitterman said.