Why aren't advisers warming up to ESG?

For ESG funds to attract more dollars, advisers are going to have to embrace the concept more enthusiastically than they have in the past

Oct 5, 2019 @ 6:00 am

By Adam Shell

The idea of investing to make money — and to make the world a better place — is becoming as common as buying an index fund.

More people want to align their capital with their values nowadays, and they want to invest in companies that are friends of the environment, champions of workplace diversity or enemies of gun violence. ESG investing, which looks through the lens of environmental, social and governance factors when selecting securities, is going mainstream — and the big growth spurt is still to come.

During the first half of the year, $8.9 billion flowed into sustainable funds, topping the record $5.5 billion for all of 2018, according to Morningstar Inc. The number of ESG mutual funds and ETFs grew nearly 50% last year to 351, with big asset managers like the Vanguard Group, Nuveen and BlackRock Inc. launching new funds.

Many of America's top CEOs, including Larry Fink of BlackRock, the world's biggest money manager, contend companies need to embrace a purpose beyond maximizing profits. Investor awareness also is rising, with three-quarters of individual investors expressing an interest in sustainable investing, according to a 2017 Morgan Stanley Institute for Sustainable Investing survey.

Still, financial advisers have yet to go all in on the trend of investing with the goal of making an impact on the world. Only 36% of advisers offered ESG investment options to clients last year, according to Nuveen's Responsible Investing Survey based on 2018 data. While that's up from 29% in 2015, it's still far from universal adoption.

A December 2018 report from Cerulli Associates noted that "financial advisers have not wholeheartedly adopted ESG mutual funds and ETFs."

Some industry experts fear advisers' slow adoption of ESG in the U.S. could put many firms at a competitive disadvantage. It's bad for business if advisers appear disinterested and uninformed about value-based investing.

"There is a huge risk to not doing it," said Brad Harrison, managing director at Tiedemann Advisors. "It is a clear trend that's not going away. Get behind it or risk losing clients."

Mutual funds and ETFs managed according to ESG principles "accounted for less than 1% of total net flows" to all funds in the past five years, Cerulli said in an August report. All told, at the end of 2018, just $161 billion was invested in funds that cite ESG in their prospectuses, said Morningstar, a fraction of the roughly $22 trillion in total U.S. fund assets.

So what's keeping financial advisers from embracing ESG?

A confusing jumble of jargon isn't helping. With an array of acronyms — ESG, RI, SRI — and words such as "impact" and "sustainable" all used to identify social investing strategies, it's hard for advisers to explain these investments to clients. Only 28% of investors surveyed by Nuveen said they knew what ESG was in the most recent survey.

"The jargon keeps investors and advisers from communicating effectively," said Megan Fielding, senior director of responsible investing at Nuveen.

The fact that there are no universal standards to define what does, and does not, constitute an ESG holding, and whether positions in funds truly align with their stated missions, results in a lack of transparency that breeds confusion and skepticism.

"That's holding things back," said Anthony DeCandido, partner at accounting firm RSM US. "There needs to be one universal framework. It's very difficult to understand what you're truly consuming as an investor. You want to know that your dollars are in fact going to an ESG-type business."

Advisers also haven't been aggressive enough when talking with clients about ESG despite growing interest. Four out of 10 advisers said they waited for the client to bring the topic up, Nuveen's survey found.

[Recommended video:How the 2020 elections could impact ESG investing]

"They are not asking clients point-blank: 'Are you interested in this?'" said Jennifer Kenning, CEO and co-founder of Align Impact, a firm that advises investors and financial advisers on ESG investments. "Advisers need to have a baseline opinion on how they look at ESG factors when they evaluate investment opportunities. They need to bring it up with clients at quarterly meetings and gauge what clients are thinking. They are reactive, not proactive."

The reactive approach isn't helping advisers get their clients on board with ESG-driven investments that address climate change, gun control and gender diversity, said Jeffrey Gitterman, co-founder of Gitterman Wealth Management. "What the world always forgets is clients don't really drive investment choices; advisers drive investment choices."

Clients likely won't put money in funds like TIAA-CREF Green Bond or Putnam Sustainable Future unless the financial adviser gives them the green light.

A lack of knowledge and comfort level with ESG concepts are another factor holding advisers back.

"An adviser not keeping pace with the material evolution of our industry is going to be left behind," Ms. Fielding said. "It's beneficial to keep up and educate yourself on ESG: What is it? What does it mean? How does it work?

Additionally, many of advisers' clients are older baby boomers who are less interested in responsible investing than younger investors like millennials. Many advisers are also in their 50s and 60s and they are less motivated to change the way they work.

Finally, many millennials, who have high interest in ESG investing according to surveys, don't have boatloads of investible assets, in part because of this group's outstanding student loan debt.

Obstacles aside, the ESG impact story that advisers can relay to clients is gaining strength.

Perceptions that ESG investments post inferior returns and can't keep pace with the market are antiquated. Fresh research by Morgan Stanley and Morningstar reiterates what academic research has shown: There's no longer a trade-off between returns and investing in a socially responsible way.

Also, a massive transfer of wealth from baby boomers to millennials provides advisers an easy entry point with younger investors who are keen on values-based investing.

Register nowfor our ESG & Impact Forum at the U.N. on Dec. 5.

Another plus: the move toward better tools to help select and measure the impact of ESG investments. Morgan Stanley recently launched a new tool that helps clients identify issues they feel strongly about, assesses whether their current holdings match their preferences and suggests investments that might be a good fit.

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