How to talk about ESG investing to your clients

The basis of sustainable investing is for companies to deliver ongoing competitive financial performance as well as create a long-term stakeholder-centric model of corporate behaviour².

To date, most of the popularity has come from institutional investors who have incorporated sustainable investment principles into their investment processes. But the latest research from RIAA indicates two-thirds of Australians they spoke to, who don't currently invest in ethical companies, funds or superannuation funds, will consider doing so in the next five years³.

Despite this positive momentum, the growth of sustainable or ESG investing is hindered by misconceptions around performance trade-offs and limited product choice. It’s time to dispel some of the myths and help you have positive and rewarding conversations about sustainable investing with your clients.

Myth 1: Sustainable investing is just the latest trend

Is sustainable investing just a buzz word? Will it eventually be replaced by a new craze when Millennials grow tired of it and find a new trend to follow?

It seems unlikely. Sustainable investing has been around for a while. It isn’t a new way of investing, but it is a new way of seeing investments for many investors and financial advisers.

While Millennials are driving much of the interest amongst retail investors³, women too are showing a high level of demand for sustainable investing options⁴. Younger Australians say they would save or invest more if they knew their money would make a positive difference and women are more likely to consider moving their banking, super or other investments to another provider if they found out their current fund was investing in companies engaged in activities not consistent with their values³.

This presents a significant opportunity for advisers to tap into sectors they have historically struggled to engage. Remarkably, 70% of women reportedly change adviser after the death of their husband and 90% of children change adviser after the death of both parents⁴. So, if advisers can confidently talk to these groups about sustainable investing and tap into their interests and concerns, it could offer a new and effective way to build long-term relationships.

Myth 2: Sustainable investing compromises investment performance

Despite research showing a positive correlation between corporate ESG practices and higher profitability, sceptics still question whether this leads to better long-term investment performance. While an ESG strategy can’t guarantee outperformance because that relies on the skill of the underlying investment manager, it shouldn’t automatically be considered as a constraint on performance⁴.

Much of the growth in sustainable investing has occurred since the GFC, so it hasn’t experienced bear market conditions, until now. COVID-19 put financial markets under severe stress and sustainable investments stood their ground².

Morningstar data shows that like all equity funds, sustainable funds endured large losses during the first quarter of 2020, but they held up better than conventional funds. Seven out of 10 sustainable equity funds finished in the top half of their Morningstar Categories, and 24 of 26 environmental, social and governance-tilted index funds outperformed their closest conventional counterparts².

Lower exposure to energy stocks helped, alongside a general overweight to technology stocks, which was the quarter's best-performing sector. However, the main reason for strong performance seems to be stock selection – companies with better ESG credentials that actively manage their environmental challenges, look after their stakeholders and undertake ethical governance practices; have proven resilent under pressure². 

Myth 3: Sustainable investment jeopardises my fiduciary duty 

Rather than jeopardising your fiduciary duty, financial advisers have an increasingly important role when helping clients understand and explore sustainable investing³.

• 90% of Australians believe it’s important financial advisers invest responsibly and ethically.
• 54% of Australians expect financial advisers to be knowledgeable about responsible investment options.
• 86% of Australians believe it’s important for financial advisers to ask about their interests and values concerning their investments.

Incorporating sustainable investing can start with the fact find process. Explore your clients’ investment goals and why they might want to invest sustainably with a series of questions⁵.

• How important is it for you to invest in companies committed to making positive changes in the world through their products or services?
• Are you more likely to purchase from a company with a better reputation?
• Do you question whether products are ethically produced or made of sustainable materials?
• Are you concerned about your personal environmental footprint?
• What types of causes do you donate time or money to? Is it important to align your wealth with the objectives of those causes?

There are generally three main reasons clients express an interest in sustainable investing⁶.

1. They want to know they’re invested in companies whose products or behaviour aligns with their ethical beliefs.
2. They want to make a difference by investing in companies that provide solutions to global problems like water supply or energy consumption.
3. They believe companies that apply ESG practices have better risk/return profiles either by reducing risk or generating alpha. 

While these might seem hugely different motivators, it doesn’t mean you need to adopt a different strategy for every client. There’s unlikely to be a one size fits all approach, but when incorporating sustainable investments into a portfolio, the same principles apply to building any diversified portfolio, and through deeper engagement with your clients you’ll likely see some common themes, which may help you create suitable model portfolios.

There are many tools available to help you identify companies or investments that are conscious of the environment and undertake the good governance and social standards your clients desire. At BT, for example, we’ve partnered with Morningstar and Sustainalytics to provide ESG research tools on BT Panorama that highlight an investment’s exposure to ESG risk and allow you to consider the sustainable approach of companies when making decisions about investments.

Myth 4: Sustainable investing is a whole new investment approach

Sustainable investing isn’t a separate asset class. Typically, sustainable investingis an umbrella term under which various strategies sit. ESG integration and corporate engagement are currently the top strategies used by institutional investors in their portfolios¹.

ESG investing is inclusive and integrative. It’s about identifying good companies who are applying business best practice for their industry. Unlike negative screening, it takes a positive focus on companies to find those less likely to face financial risks such as fines, lawsuits, and reputational damage⁷.

You can find ESG investment options across all asset classes and investment styles, so you don’t necessarily need to allocate a separate part of a portfolio to cater for it⁵. Depending on your clients’ needs, it may be appropriate to have investments that integrate sustainability as a core investment component, or you might prefer to have a satellite investment in a thematic, sustainability fund or impact investment instead.

Understanding and engaging with clients

In a difficult marketplace, incorporating sustainability into your core service offering is an effective way to differentiate and add value for clients. It’s also a key tool for attracting new clients, perhaps expanding into segments you haven’t previously serviced. If you have the right tools to support you and a strong knowledge base, sustainable investing could be a rewarding way to connect with clients and give them greater confidence in their investments.

References

1 https://responsibleinvestment.org/wp-content/uploads/2019/07/RIAA-RI-Benchmark-Report-Australia-2019-2.pdf
2 https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-quarter-better-than-conventional-funds
3 https://responsibleinvestment.org/wp-content/uploads/2017/11/From-values-to-riches-Charting-consumer-attitudes-and-demand-for-responsible-investing-in-Australia-2017.pdf
4 https://www.morningstar.com.au/learn/article/financial-advisers-and-esg/196239?q=printme
5 https://www.im.natixis.com/us/esg/dispelling-esg-and-sustainable-investing-myths
6 https://citywireasia.com/news/clients-want-to-invest-sustainably-but-need-advice/a1045863
7 https://www.morningstar.com.au/learn/article/esg-and-sustainable-investing-a-guide/199556

Next: The ABC of sustainable investing - making ESG work for your advice practice