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Portfolio > Portfolio Construction > ESG

Will Advisors Finally Embrace ESG and Sustainable Investing in 2018?

By Bernice Napach By Michael S. Fischer

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There’s no doubt that interest in ESG, impact and sustainable investing is growing. But while many institutional investors have embraced those assets, managing almost $23 trillion of them globally, many financial advisors have not. “Advisors have been lagging,” said Jeff Gitterman, founder of Gitterman Wealth Management, which has offices in New York and northern New Jersey.

This year could be when advisors begin to embrace environmental, social and governance focused investing because an increasing number of clients are demanding it. “You can’t have all that client demand and so little advisor distribution,” explained Gitterman. Those advisors that aren’t offering ESG opportunities “will lose clients.”

At a minimum, they probably won’t attract as much next-generation millennial money or as many new female clients as they could since those populations are reportedly the biggest fans of ESG assets in the retail market.

Clients interested in ESG investing are “probably the fastest growing” segment among new clients at Capital Intelligence Associates, says Mitchell Kraus, a principal and co-founder of the Santa Monica, California-based multigenerational wealth management firm. “We find that female and younger clients tend to want ESG investments more than older males but there is no [ESG client] ‘type,’” he explained.

Kraus asks every client about ESG investing as part of his conversations about their goals and objectives. In the past, he would discuss ESG investing only after a client brought it up.

Many advisors are not embracing sustainable investments because of fears of the unknown and concerns about forfeiting returns, according to Erika Karp, founder of Cornerstone Capital Group, a New York-based firm that specializes in sustainable investing. “There needs to be a lot of education” and debunking of “the myth of underperforming,” she said. “The data is showing the opposite.”

Also needed, Karp explains, is more and better disclosure by companies about their ESG data that’s “linked to revenues, costs and risks … to issues relevant to their economic performance.”

“Over the long-term having a good ESG rating may become an important factor for individual securities,” said Martin Kremenstein, head of NuShares, Nuveen’s ETF division. Kremenstein sees a growing interest in ESG investments — NuShares has eight ESG ETFs on the market — and expects ESG will represent a significant share of the investment market longer term.

Tim Freundlich, who heads ImpactAssets, a $350 million boutique donor-advised fund that specializes in impact investments, expects that middle-market RIAs and registered reps with $5 billion to $15 billion in assets under management will soon follow the bigger players into impact investments next year. “They are nimbler and client-driven and they’re going to leap ahead of the big bank RIA wealth management platforms.”

He expects such advisors will invest not only in publicly traded stocks scoring high on ESG measures but also in private equity and private debt focused on making an impact, which could also be included in donor-advised funds. Such funds “represent a huge opportunity for integrating impact and sustainable investing,” Freundlich says.

Both Freundlich and Gitterman believe climate change and gender equality will be among the key impact areas favored by investors and advisors involved in sustainable investing in 2018. “Given what’s happened in the last three months and the groundwork already done, 2018 could be the breakout year for awareness and integration of gender-lens investing,” said Freundlich.

There are only 12 years to go to 2030, the target year for achieving the United Nation’s sustainable development goals (SDG) for a habitable planet. Gitterman expects there will be more SDG-themed funds coming to market in 2018 as well as refinement of the sustainability measures. Among the 17 SDG themes are gender equality, elimination of poverty, clean water and sanitation, climate action and quality education.

Index Managers & Stewardship

As assets continue to pour into passive strategies and responsible investing becomes more important, index managers’ stewardship activities can be expected to receive greater scrutiny. A recent study by Morningstar seeks to understand the stewardship activities of these providers of index-tracking investments, including traditional index funds, exchange-traded funds and segregated mandates.

Morningstar surveyed the 12 largest index providers across the U.S., Europe and Asia, including both global firms, such as BlackRock and Vanguard, and smaller ones that are key passive fund providers in their local markets, such as Schwab and Lyxor. Most also operate an active fund business that in some cases is much larger than their passive one. Collectively, they manage more than $20 trillion in assets.

“Our research shows that the shift to index investing hasn’t led to an abdication of stewardship responsibilities,” explained Hortense Bioy, director of passive funds research at Morningstar, in a summary of the study findings.

The survey findings show that the biggest index managers have expanded their stewardship or corporate-governance teams and are increasingly committed to improving the environmental, social and governance practices of their holdings through proxy voting and engagement.

Several factors have prompted large asset owners to push for increased oversight: the belief that ESG integration and active ownership practices can positively affect investment performance; regulators’ adoption of stewardship codes, including in the U.K., Japan and Switzerland; and the huge growth of the assets they manage.

Voting Behavior

Index managers’ role as active owners is important because they are the ultimate long-term shareholders of listed companies, says Bioy. Unlike active portfolio managers, they cannot sell poorly run companies, and so must encourage positive change through voting and engagement.

But index managers do not all undertake stewardship activities in the same way. The data show that voting and engagement activities vary not just according to the size and predominant investment style (passive or active), but also according to asset managers’ philosophy, region and history.

The scope of voting varies widely across asset managers, depending primarily on their size. Global managers typically vote for all portfolio holdings where possible if the potential benefit of voting outweighs the cost of exercising the right. By contrast, smaller firms focus more on their home country or region, or on their largest holdings.

All surveyed asset managers start by supporting company management and boards, as most votes are linked to routine administrative matters. However, voting records turn up significant differences among firms in how they voted, especially with respect to voting against management.

Bioy notes that anecdotal evidence of mounting dissent is beginning to crop up, particularly in the case of U.S. asset managers, which relative to European ones have been historically more reluctant to challenge the status quo, especially in relation to environmental and social issues.

At the same time, index portfolio managers have no say in the voting of their holdings. Bioy points out that for the highly automated index portfolio management process, delivering index performance is the overriding mandate.

The Morningstar research shows that nine of the 12 firms in the study reported that they had undertaken direct engagement activities with companies and were willing to increase their engagements in the future.

As for disclosure practices, these differ greatly between managers and countries owing to national regulatory requirements and customs. Bioy writes that most surveyed asset managers publish their funds’ voting records on their websites in countries where the regulator or a stewardship code requires this. But these records are frequently hard to find, and may not exist where disclosure is not required.

Morningstar expects increased disclosure of voting and engagement activities, as well as for index managers to become more vocal on ESG topics. Ultimately, this should influence their product offerings — as it already has in the case of SPDR SSGA Gender Diversity ETF (SHE).

Bernice Napach

@Think_Napach

Michael S. Fischer

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