3 tips for advisors to make sense of ESG investing

September 24, 2023 8:00 AM

ESG concept of environmental social and governance

It can be hard for today's advisors to wrap their heads around meaningfully engaging with portfolios informed by environmental, social and governance factors, or sustainability.

The ESG craze of the past few years saw big asset managers on Wall Street, from BlackRock to Vanguard to State Street, crowd into what had once been the focus of specialists, with many new funds labeled "ESG" that critics said were superficially constructed to appear sustainable. PwC estimated last year that global asset managers were expected to oversee $33.9 trillion in ESG-related assets by 2026, up from $18.4 trillion In 2021.

Yet recently, the political right-wing backlash against ESG-based investing and poor short-term performance of several ESG funds, as well as investor movement out of those funds, have led asset managers to shutter several of them, according to Morningstar data. "The more divisive environment, of course, that's difficult for everybody, and it's having the intended chilling effect on the market overall," said Blaine Townsend, the head of the Sustainable, Responsible, and Impact Investing Group at Bailard, an RIA in the San Francisco Bay Area.

"But if you just focus on, what are the values that your client would like to see reflected in a portfolio? It should be the same conversation that you had 20 years ago. And the good news is, there's many more options to deliver these portfolios to clients."

For Peter "Pete" Krull, a longtime specialist in this area who was in New York during Climate Week NYC (Sep. 17-24), there's clearly still interest from both advisors and clients in ESG. He attended the ICE Climate and Capital Conference at the NYSE and noticed plenty of advisors there.

"There were a lot of people on the institutional side there," Krull said. "So it was good to see that kind of attendance at the event."

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Krull is the partner and director of sustainable investing at Earth Equity Advisors, an RIA which was recently acquired by fellow RIA Prime Capital Investment Advisors Company, in Asheville, North Carolina. He believes that ESG still holds value as a term because it provides key ways for advisors to screen for "material risks" to a client's portfolio — especially in the form of climate change and its documented economic impacts.

So where do advisors go from here? Krull and Townsend shared their thoughts with FP on what's next for ESG and/or sustainable investing, and how advisors hoping to engage with these trends can seek clarity in the fog. Below are three tips.

*Note: ESG is not thought of as equivalent to sustainability, but the two terms often appear in the same conversations. ESG is considered a set of criteria used for evaluating investments, often with the aim of producing a portfolio that supports sustainability. Sustainable investing is a strategy that seeks returns with long-term environmentally and socially healthy, or sustainable, outcomes.

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Think in terms of 5-10 year investing windows

Krull said much of the recent media buzz surrounding ESG and sustainable investing performance reflects confusion over how truly sustainable investments grow.

"First and foremost, we're long-term investors. And so short-term volatility is something that we've always spoken about with clients, in terms of: There's going to be ups, and there's going to be downs." Krull said sustainable investing shouldn't be thought of as value investing, where the focus is on buying cheap — instead, it's based on a growth investing philosophy, investing in a business expected to grow aggressively in future years. "When value is in play, growth typically doesn't perform. When growth is in play, value typically doesn't perform. They move conversely to each other."

Looking only at performance over one to two years won't do justice to this approach, Krull said. "You see a lot closer performance to the benchmarks, when you go three to five, and certainly when you go 10, years out." Although at times he might change portfolios to shift to the value side more, his baseline is: "We're never going to put fossil fuels in there. We're never going to put the big banks in there, or other more value-oriented investments."

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Partner with specialists

An advisor doesn't have to be an expert on ESG or sustainability, Townsend said, given the complexity involved in assessing companies for the right metrics. They could instead outsource to partners who have reliable track records suited to their clients' interests and values.

"They have to first identify … what are the social and environmental issues our clients care about, which every advisor should want to know. That's a really important part of a lasting long-term relationship. And then they need to find managers who can explain their strategy to the client."

To vet the right asset manager partner — which Townsend considers Bailard to be one of — advisors can look for whether the firm has in-house research capacities to track those metrics.

Another thing to look for is their public presence around ESG, Townsend said. "What are they researching? What are they writing about?… Do they have a proprietary, in-house way of looking at these sustainable, responsible and ESG issues? Do they do stakeholder work? Are they doing anything outside of the portfolio? Does the organization itself reflect some of the same values?"

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Upskill with reputable credentials

Advisors looking to work with clients on sustainable investing can either demonstrate a long track record of deep focus on this work, to avoid accusations of greenwashing, or stand out by obtaining a certification with a credible licensing body. Krull said he recommends the CSRIC, or Chartered SRI Counselor, designation, which is offered by Kaplan's College of Financial Planning and helps advisors understand sustainable, responsible and impact investing.

"I was one of the first few to get it," he said, adding that the certification came out a few years ago. Advisors who lack the time to get it on their own can look to partner with others who have it, or similar legitimate-looking certifications, since, in the meantime, the industry still lacks rules that could clarify what's truly "ESG" and what isn't.

"We're actually coming from the ground up, trying to make portfolios that are impactful and solutions-based," Krull said. "But at the end of the day, it would be nice to have a level playing field with the big guys who aren't afraid to greenwash."