ESG Is Alive and Well

It has been an uphill battle for investing with a concentration on environmental, social, and governance (ESG) issues of late. In the wealth management industry, where caution is highly prized, marketing volatile products such as ESG funds can be a difficult sales pitch.

The trajectory of ESG ETFs from record inflows in 2021 to their worst-ever outflows by 2023 reveals that investors have strongly opposed overhyped ESG credentials.

In 2023, 61% of financial advisors expected to avoid recommending ESG products to clients, while a mere 14% indicated they were highly likely to recommend them, according to Arizent’s “Predictions 2024” study.

Thomas Kuh, head of ESG strategy at Morningstar Indexes recently noted that investors remain committed to implementing ESG strategies in their portfolios, but there are challenges pertaining to “lack of regulatory clarity” and a need for “better data and resources.”

Many financial advisors have largely been skeptical about ESG investing, citing concerns about performance, fiduciary responsibilities, and the perceived subjectivity of ESG criteria. However, as the economy evolves, societal values shift, and a new generation of investors becomes more prominent, wealth managers may need to reconsider their approach to ESG investing.

Although it has encountered political backlash and record outflows, many experts believe that ESG investing has a stable and growing place in the future of investment.

According to a new study published by global professional services firm Deloitte and The Fletcher School at Tufts University, most professional investors have implemented ESG investment policies in recent years, with investors looking to minimize sustainability-related risk while also capitalizing on opportunities, citing factors such as regulatory requirements, improved performance, and talent attraction.

The survey of over 1,000 asset owners, asset managers, and investment advisors, including CEOs, CIOs, heads of strategy, and other senior investment executives, discovered a significant increase in the proportion of investors establishing sustainable investment policies, with 79% reporting a policy in place, up from 20% five years ago.

“Many factors, including evolving regulatory requirements, financial performance pressures, and stakeholder expectations, are driving the U.S. movement toward integrating sustainability and ESG into investment decision-making,” said Chris Ruggeri, a Deloitte risk & financial advisory principal and sustainability, climate and equity leader.”

Details, Details, Details

Corporate executives and fund managers are increasingly looking to present investors with exact wording and detailed information to demonstrate a company’s commitment to issues that are material to its business. Evaluating a company’s environmental and societal implications is more than just an idea; it is a type of due diligence.

“Some ESG metrics, the true ones, are actually related to firm risk,” said Sam Adams, CEO of Vert Asset Management, a Sausalito, CA-based ESG fund manager. “So ESG will grow, it will continue to thrive and become a bigger part of the investment landscape because it is additional information. And all investors, whether sustainability-minded or not, want additional information on risk.”

At the same time, U.S. investors were more likely than their foreign counterparts to have sustainable investment plans in place, with 83% of investors reporting such strategies, up from 27% five years ago, the Deloitte – Fletcher School survey also found.

“As such, company leaders and their boards have an important opportunity to take actions that can improve investor confidence and trust levels in those investments, such as making enhancements to the sustainability information, disclosures, and other sources that inform buy, sell, and hold decisions,” Ruggeri added.

The Shareholder Level

Many wealth managers are offering their clients ESG products that demonstrate the specific actions performed at the shareholder level. “When the bank makes an investment in a company, its representatives – usually investment managers – are present at that company’s shareholder meetings, and advocate through shareholder activism,” explained Accenture’s Zabeen Moser, managing director, wealth management Europe. “These actions and the eventual outcomes are then communicated back to clients through the reporting on their investments.”

This level of commitment contrasts sharply with the usual approach of wealth managers. However, it is precisely what many of the next generation of clientele seek. It has long been understood that these, primarily younger, clients prefer their wealth managers to offer sustainability or ESG investments.

But the “sustainable” designation is no longer sufficient. Instead, a growing number of clients want to look under the hood to grasp what sustainability entails.

The millennial and Gen Z generational transition implies that the client base is rapidly shifting toward those who care about sustainability and want proof that their investments are helping rather than hindering it.

As ESG investment becomes more widespread, wealth managers must recognize that it is not a temporary fad. Wealth managers can also develop deeper and more enduring relationships with their clients by providing insights into the real implications of their investments.

Many funds now state in their prospectuses that ESG factors will be addressed at some stage throughout the investment process. And this appears to be continuing, given most asset managers’ ESG pledges and the possibility for ESG funds to outperform.