Fearless Girl The “Fearless Girl” statue when it was facing the Charging Bull. (Photo: Federica Valabrega)

Despite high overall industry growth rates and satisfaction scores for investors with sustainable investments, environmental, social and governance adoption among the financial advisor community has been slow.

State Street Global Advisors released a new report detailing how advisors can overcome the key challenges slowing the adoption of ESG investment strategies.

With 50% of ESG investors planning to increase the degree to which they incorporate ESG in their portfolio in the next three years, and 23% of non-ESG investors planning to add ESG, the report provides advisors with a clear path for overcoming three major hurdles.

ThinkAdvisor spoke with Brie Williams, head of practice management at State Street Global Advisors, about the report, Aim Higher: Helping Investors Move from Ambition to Action with ESG Investment Approaches, and the following three hurdles that she said are specific to the advisor community.

1. Confusion around investment performance parity.

The report clarifies that ESG is not just a “do good” mentality. Or as Williams told ThinkAdvisor, “this is an investment, not a donation.”

Rather, financial performance is what keeps clients interested and invested. The report states that 60% of ESG investors cite lower volatility and 54% cite lower downside risk as important reasons for incorporating ESG into their investment process, according to a 2016 State Street Center for Applied Research Survey of Retail Investors.

Industry and academic studies offer empirical evidence for better long-term risk-adjusted returns, lower downside and improved volatility in ESG strategies.

“There’s numerous data points — whether you look to academia or other investment studies that show there is performance here and it is not an either/or,” Williams said. “You don’t have to sacrifice returns. [ESG] actually has a role and a role that’s designed to help reduce risk as well as keep investors engaged for the long haul.”

According to the report, mutual funds and separately managed accounts classified as sustainable investments often meet or exceed broad market performance, both on an absolute and a risk-adjusted basis, across asset classes and over time.

In addition, the report points to analyses from Mercer, Morningstar and University of Oxford that have found mostly favorable or neutral-to-favorable returns on socially responsible investing.

2. Need for transparency and better data.

Better company data combined with better ESG research and analytics will lead to more advanced approaches to identifying and addressing material ESG issues, according to the report.

There has been significant progress in the number of companies disclosing ESG data, along with the breadth and depth of their data. However, as the report points out, reporting methodologies still vary among companies, index providers and asset managers, creating challenges for investors seeking to compare ESG strategies.

“There is no standardization, and that’s the biggest challenge,” Williams explained. “You have different companies with different reporting methodologies, which can make that very challenging when analyzing the options available and how they should consider their choices.”

The lack of consistency in reporting on material issues leaves room for some degree of subjectivity. The report gives the following example: “A company’s rating on carbon output could be qualitative (management is committed to improving emissions), quantitative (proven reduction in carbon output by 25% by 2020), or binary (yes, the company has goals related to carbon emissions).”

Efforts to improve data are focusing generally on more quantitative data, along with better application of qualitative data.

The push for standardization of reporting across companies will help provide even greater transparency. In addition, improved reporting can help advisors be proactive with their communications and more responsive to specific client inquiries, according to the report.

3. Choice overload.

Investors’ need for advice in navigating a large and growing set of ESG options presents an opportunity for advisors to provide value in a meaningful way, according to the report.

The nature of this conversation is that it’s focused on client goals and it highlights the advisor’s value-add.

“What are [the investor’s] goals and what are the different solutions out there?” Williams explained. “The nature of the conversation has to begin with the clients’ goals. It’s a very client-centric discussion and framing the conversation with what they have in mind to achieve.”

For example, some clients may want to dip a toe into ESG investing; others may want to commit a significant part of their portfolio.

Advisors will need to discuss the scope of the portfolio, as well as the intended impact the investor wants.

To do this, the advisor will need to identify the right ESG strategy — thematic (renewable energy, for example), targeted (environmental, for example) or comprehensive (ESG as a whole). The advisors will also then need to determine what investment vehicle — mutual funds, ETFs, separate accounts, model portfolio or full integration — is best to do so.

The report notes that “effective integration of ESG principles into a portfolio begins with a client-focused process — not a product-focused process.”

The report also stresses that this conversation is not a one-and-done achievement, because client motivations will shift over time and portfolios should adapt to changes.

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