ESG investing: what do your clientsneed to know?
In the last ten years, billions of dollars have been poured into ESG funds as investors have become increasingly concerned with the environmental and social impacts of doing business. In this article, we’ll cover all the ESG basics and detail the five questions you need to ask your clients if they’re considering investing in an ESG fund.
What is ESG investing?
ESG stands for Environment, Social and Governance. These are the three critical non-financial motivators that companies consider when making investments.
Together, they’ve come to represent a type of investment that is less driven by profit and more driven by these motivators. A type of investment concerned with improving the well-being of humanity, the planet and the economy.
Previous names for this include sustainable investing or impact investing, but ESG investing has become the standard term of late.
Common ESG investment concerns include an organization’s commitment to mitigating climate change or issues like biodiversity loss, the welfare of human beings within a company’s supply chain and workplace diversity/equality of opportunity.
The current state of ESG investing
ESG investing is experiencing a huge boom, and financial advisors are being asked about their investments’ social credentials more and more often.
From January 2020 to March 2020, for example, $45.6 billion was invested into ESG funds worldwide.
The impulse to invest sustainably only increased throughout 2021. From January 2021 to November 2021, $649 billion flowed into ESG funds globally, and these types of investments now account for 10 per cent of all global fund assets.
For many businesses, brand and reputation have overtaken returns as the main reason for making ESG investments.
That reasoning had risen from 47 per cent to 59 per cent by companies surveyed in the Global ESG Survey 2021.
All over the world, organizations are taking more notice of social issues than ever before. They know what matters to their customers and reflect these values.
The US is currently leading the way in terms of expansion. Since 2020, it has experienced 40 per cent growth in ESG investments and is expected to account for more than $20 trillion of ESG investments this year.
The numbers are staggering, and they make one thing very clear: For both financial advisors and their clients, sustainable investments present an enormous opportunity for high returns.
From January 2020 to March 2020, $45.6 billion was invested into ESG funds worldwide
The pros of ESG investing
Aligning finances with values – Investing in assets and companies that do less harm globally is hugely motivating for many clients and investors
Possible positive impact on portfolio returns – A study of over 2,000 companies showed that 63 per cent register a positive correlation between ESG investment and returns
Lower levels of associated risk – ESG assets are less likely to contend with accidents, fraud, lawsuits and other negative factors that would affect an investment
Activism and leverage – ESG investing allows clients and shareholders to apply pressure on companies, for instance, by demanding a reduction in emissions or a better diversity policy
Innovation and growth – Currently, ESG assets are scalable, meaning they can result in better returns, higher profits and higher share prices
The cons of ESG investing
Performance is pushing prices up – Though ESG investments are currently performing well, this will eventually push the price up. Higher pricing means potentially poorer future returns
Alignment of goals – Many ESG assets may not have evidence of their impact on people and the planet. This means actions may not align with an investor’s original goals
Consistency and changing ratings – Because the ratings of ESG funds change all the time, they may not have that much value to investors
Low shareholder activism – Many of the larger ESG providers don’t engage themselves in shareholder activism, which is often an unrealized reason for investing in the first place
Higher associated costs – Because they must manage more costs than traditional investments (e.g., research and activism), ESGs can create large expenses and reduce profit
What should you be asking clients interested in ESG?
Good financial advice is all about trust and understanding.
Without understanding your client’s investment goals, it’s impossible to determine whether an ESG fund is right for them.
There are five questions you’ll need to ask before exploring options further.
Your client’s answers will help you narrow down where they’ll feel happiest sending their money and what kind of returns they expect to make.
1. How strongly do you feel about a company’s social investment goals? – From reducing their climate footprint to ending slave labor, knowing how much a potential investor cares about different social responsibility issues is essential. That will let you know how amenable they are to ESG investments
2. How quickly would you like to see returns? – One downside to ESGs is that they tend to offer returns over a longer-term timeline. An ESG may not be a good option if your client wants a faster return
3. Are you interested in having outperforming companies in your portfolio? – Many ESG funds are now outperforming their competitors. If the client wants to improve their portfolio with outperforming companies, ESG investments are a great choice
4. Do you want visibility on how much good your investment is doing? – Because ESGs are mainly measured on their relationship to risk, it can be hard to register their impact. If your client wants to see that impact, focus on finding an investment that can evidence its results
5. Are there any sectors you’d rather avoid investing in? – Your client may care far more about some issues than others. It’s essential to narrow down their preferences, and knowing what they don’t want to invest in presents other opportunities
How will ESG investments grow your business?
In the post-pandemic financial world, things look bright for ESG funds.
With vast amounts of money in this budding area of investing, the opportunity for financial advice businesses to grow with their clients’ portfolios is enormous.
And because many ESG investors are young, the appetite for expansion into sustainable assets will only increase with time.
ESGs can grow your business by attracting new customers, involving you in recognizably good causes and helping Millennial and Gen Z investors gain huge returns.
The more ESGs impact the world, the more people will want to invest.
Kate has written for leading publications and blue chip companies over the last 20 years.