Sustainable Investing: Taking the Lead on Education and Implementation
This blog is part of a series that highlights insights from my upcoming book Goals-Based Investing.
Book Review
“In his book Goals-Based Investing, Tony Davidow fuses the diverse landscape of investing into one succinct and comprehensive treatment to help investors navigate the world of wealth management. Whether you are a financial advisor or DIY investor, you will find relevant insights to help build and manage portfolios. From behavioral finance, to alternative assets, to sustainable investing, and more, Davidow covers it all.”
— Margaret M. Towle, PhD., CIMA®, CPWA®, Yakima River Partners, LLC
One of the biggest trends across the financial services industry has been the growth of sustainable investing, in both the number of products and the asset growth over the past couple of years. Even with this rapid growth, there is still a false narrative that doing good in your portfolio means that you must give up returns, and consequently some advisors and investors have been slow to embrace sustainable investing strategies. Institutional investors in Europe, public funds, endowments, foundations, family offices, women, and millennials have led the adoption of these misunderstood strategies.
We have begun to see broader adoption across all client segments in the past couple of years – but there is still a great deal of confusion among advisors and investors. Several factors have led to confusion and the initial slow adoption of sustainable investing. The terminology used to describe this approach—socially responsible investing (SRI); environmental, social, and governance (ESG); impact investing; and sustainable investing—is perhaps the biggest area of confusion. The terms are often used interchangeably, but there are differences with the screening approaches of each.
What is Sustainable Investing?
In the 1990s, SRI became a convenient way to express views about unpopular activities. Investors opposing apartheid could exclude companies doing business in South Africa from their portfolios. Investors could express their displeasure with tobacco, alcohol, or gaming by excluding sin stocks or eliminating companies that damaged the environment from their client portfolios. Excluding these companies often meant sacrificing returns, however, so many investors shied away from socially responsible investing.
Sustainable Investing Spectrum
Source: Morgan Stanley Institute of Sustainable Investing
In the past couple of years, ESG screening has become increasingly popular with large institutions, HNW families, women, and millennials. This relative screening methodology assigns the highest weights to companies that exhibit the best practices. Multiple studies have shown that these strategies have historically outperformed their comparable unconstrained indices.
Impact investing is focused on affecting changes primarily in private companies. There are a growing number of private equity funds focused on impact investing. Family offices often invest in causes that align with the family’s passion and legacy planning (i.e., education, the arts, renewable energy, cancer research, etc.).
Sustainable investing is a broad descriptor that includes socially responsible investing, environmental, social, and governance, and impact investing and has grown substantially. According to the US SIF biennial report, the total US assets under management for sustainable investing grew from $12 trillion in 2018 to $17.1 trillion in 2020, an increase of 42 percent. This represents nearly one-third of the US professional assets under management, an astounding 25-fold increase, or 14 percent annualized growth rate, since 1995. That’s a significant accomplishment, especially given the skepticism outlined above.
The report breaks down the sustainable investing assets under management at the beginning of 2020 into mutual funds (>$3 trillion), other commingled funds ($865 billion), alternative investments ($716 billion), ETFs ($21 billion), variable annuity ($17 billion), and other investment vehicles ($11.5 trillion). The last group includes UCITs and separately managed accounts.
The number of alternative investment sustainable investing vehicles grew substantially. The US SIF 2020 trends report identified $716 billion in ESG assets under management across 905 alternative investment vehicles at the start of 2020, representing a 22 percent increase in assets compared to 2018, and a 16 percent increase in the number of funds. Private equity and venture capital ESG funds represent the largest number of alternative funds and increased 21 percent to 681 funds. Assets under management increased 55 percent to $438 billion.
If we dig into client segments, we see that sustainable investing by family offices increased 50 percent, from $4 billion to $6 billion, over the past two years. In 2020, the top issues for family offices were climate change, carbon emissions, and clean technology. Educational institutions held $378 billion in sustainably invested assets at the start of 2020—an increase of 19 percent from 2018— with a focus on climate change and carbon emissions.
The largest segment of sustainably invested money is in public funds: roughly $3.4 trillion, or a 10 percent increase over 2018. Sustainable Investing Public funds include assets managed for federal, state, county, and municipal governments, including public employee pension plans such as CalPERS and CalSTRS. The report identified 181 public funds subject to various sustainability criteria, roughly the same as in 2018.
The Role of Wealth Advisors
Wealth advisors should take the lead in educating investors about the merits of sustainable investing and how these strategies can be incorporated in portfolios. Wealth management is not about maximizing returns, but rather about making sure that a strategy provides the highest probability of achieving a client’s goals. Those goals may include aligning the investor’s purpose and portfolio. With millennials and Gen Z investors representing a larger percentage of the workforce, and more-and-more investors gravitating to sustainable investing, wealth advisors need to engage investors and educate them about the merits of sustainable investing options. If wealth advisors fail to address these issues, millennials and Gen Z investors may feel compelled to find advisors who have similar values and perspectives.
According to a 2020 McKinsey report, an unprecedented amount of assets will shift into the hands of US women over the next three to five years, creating a $30 trillion opportunity by the end of the decade. Today, women control roughly a third of the overall wealth, or $11 trillion in assets, and will likely inherit additional wealth as their older spouses pass. Women tend to make different investment decisions than their male counterparts. They are often more risk averse and are more focused on achieving life goals. Multiple studies have shown that women consider social, environmental, and political issues in making decisions.
HNW investors are often focused on their legacy and giving back to society. Incorporating some form of sustainable investing can further their causes. Wealth advisors need to inquire about a family’s passions and determine whether these should be incorporated in the family’s portfolio. Inquiring about these interests also demonstrates the scope of capabilities. An HNW family may not perceive sustainability as part of their current advisor’s expertise and value proposition - and may choose to seek out advisors with the expertise and ability to educate the broader family.
The bottom line is sustainable investing is not a fad, or even a niche strategy; it has become a mainstream approach to investing capital and has been adopted across client segments. Wealth advisors should seize the opportunity to differentiate their approach and value proposition - and educating investors may pay big dividends in the future.