My firm has sponsored a series of surveys, trying to understand what is driving retail investors. Some of the answers have come back exactly as expected — consumers value high performance, they don't believe they have enough saved for retirement — but others have surprised us.
One example: women and millennials report increasing interest in and want to buy funds with strong environmental, social responsibility and corporate governance (ESG) components. Yet investors tell us that few financial advisers are suggesting, let alone recommending, these funds.
If investors are coming in predisposed to purchasing ESG funds, why aren't FAs getting out front? Only they can say, but they risk missing opportunities to serve their clients' interests.
Surveys show that “socially-responsible investing” (SRI) is an almost universally familiar term. Whether also called “sustainability” or ESG, it's here to stay. It can identify all the attributes we expect from strong, successful companies that are well-positioned for the future. While no equity fund is without risk, these are the most likely companies to contribute to the greater good, while also providing investment value. Investors want to serve both their moral and economic values. With ESG funds there need be no trade-offs.
I have written here on this topic before, yet as our surveys demonstrate, the landscape has continued to evolve.
Once vehicles for screening out “sin” stocks (which have often been middling performers anyway), ESG funds now encompass a broad range of quality factors. They emphasize strong corporate governance and sustainability practices that many industry leaders are adopting: put simply, many are better companies that have outperformed their peers. ESG broadly means assessing transparency, regulatory compliance, board policies, executive compensation, community engagement, and sustainability and other environmental and energy-saving initiatives.
It goes further: at our ClearBridge affiliate, analysts track key ESG factors specific to the industries they cover. For healthcare this includes regulatory risk, reputational risk and the sustainable clinical benefits of new products; for financials, they look at compensation structures, deferred mechanisms, lending practices and talent acquisition/retention; and for energy/utilities they evaluate climate legislation, asset mix, clean fuels, operational history and carbon profile.
This provides a deeper view of what the company is doing — and a better sense for its true value.
Fortunately, despite not being out-front in selling ESG funds, many financial advisers do not report a negative bias toward SRI performance.That's good, because our industry has introduced many funds that focus on ESG and have delivered attractive investment performance. Again, there are no trade-offs required. Going forward, ESG may not be a slam dunk, but recent results have been impressive in many funds, and investors have some good options to choose from.
Morningstar launched sustainability ratings in March 2016. Looking at investment performance for approximately 20,000 funds classified “sustainable” in Morningstar's database, 56% ranked in the first or second quartile for 3-year trailing performance; for 5-year trailing performance, 55%, against their respective benchmarks.
Those who report the greatest interest in ESG funds, according to our surveys, are high net worth individuals (HNW) and millennials. In both cases there was a slight bias to women. The majority of these investors do not believe ESG funds are riskier or perform worse than other investments: only 1 in 5 respondents believed performance suffers; and only 1 in 6 believe risk increases.
While performance has been generally good, HNW (59%) and Millennials (64%) indicated willingness to sacrifice some long-term return to invest in SRI; 18% of HNW and 11% of millennials said they are not willing to give up any return. Clearly the socially responsible aspects of investment also matter and may balance if not override concerns over performance — since as we must always remind investors not all investments make money, particularly over the short term, no matter how well-chosen.
This also bodes well for ESG products to be “sticky,” something another survey showed may be a problem with the rising millennial generation: in a poll in January 2016 sponsored by Legg Mason of more than 5,000 wealthy individuals across 19 countries, fewer than 1 in 5 millennials said they would hold underperforming funds for more than a year before dumping them. By contrast, investors over 40 said they were almost three times more likely to hold onto poorly performing funds.
So if we can sell millennials products they can believe in, perhaps they will hold onto them for the long-term rather than sell at the wrong times. As anyone who has seen more than one full market cycle knows, moving in and out of the markets is unlikely to bring positive returns.
Thomas Hoops is executive vice president of product development at Legg Mason