Journal of Financial Planning / Next Generation Planner: April 2021
By Angela Parker, MSF, CFP®
Financial Adviser, WGG Wealth Partners
Since 2015, the universe of funds focused on sustainability has leapt by a few dozen per year. However, the events of 2020 seem to have brought investors to the scene in droves, with record-setting inflows, potentially sending fund managers rushing to expand their options to meet the demand. If it hasn’t happened in your practice already, it may not be long before a client asks what this all means and if it’s something they should look at as well. A few key points can help you be prepared with an answer.
What Is an ESG Fund?
Born of a desire to divert funds away from unwanted practices, or into those which are desired, ESG (which stands for environmental, social and governance) funds are often used by investors who want to harness their money’s power to encourage change. They can target particular sectors, such as a fund of woman-owned businesses, or use a screening approach, such as a S&P 500 ESG fund that excludes companies in the index with a track record of poor corporate governance
Historically, ESG funds have trailed traditional funds in performance, in large part because they excluded tobacco and oil stocks. The success of the tech industry has helped to level the playing field by offering investors growth-driven options in new sectors. This change has been fueled even further by the global concern over climate change. Companies that fail in ESG areas are starting to be spotlighted, boycotted, protested against, and held accountable by consumers and government bodies. We know that poor corporate behavior turns into poor results for shareholders. ESG funds seek to identify those companies before the shareholder takes a hit.
Who Uses ESG Funds and Why?
ESG investing is purposeful investing. Investors seek ESG funds for reasons generally rooted in their goals and values—key points for any planner attempting to draw up their financial road map. If your client is asking about ESG funds, they are indicating that something more than investment performance concerns them. We quickly get comfortable with asking a client about their risk tolerance, their desired retirement date, or if they intend to cover their children’s college costs. This is an opportunity to take the planning a step further and ask, “What do you wish to accomplish with your portfolio, aside from reaching your personal financial goals?”
Money invested is money at work, and while we certainly want that money to work for us, some investors also want that money to work for others. However, adding an ESG fund to a portfolio may not be the only way for your client to achieve that goal.
How to ESG When You Don’t ESG
If you are not a proponent of ESG investing, facing a client who brings the conversation to you might prompt anxiety. However, sidestepping the question will likely send the client seeking a better answer elsewhere. The best place to start the ESG conversation is to dig beyond the client’s initial inquiry by asking a few key questions in return:
- Why is this topic important to you?
- What inspired you to ask?
- What do you hope to achieve?
In response to their answers to these questions, you can consider a few for yourself:
- Are they a good candidate for a donor-advised fund?
- Does their estate plan support their causes?
- Is there is a religious, ethnic or cultural background that I need to be respectful of?
- Is there an interest I should target in a future marketing campaign or client event?
Uncovering the motivation will strengthen your understanding of your client and improve your recommendations by aligning them with their specific wants and needs.
When Is the Trade-Off Worth It?
Funds invested in ESG funds are funds not available to invest elsewhere, so for the client who must have a bottom-line return to stretch their dollars through their retirement, you can make a strong argument that investing for moral goals can be damaging to financial goals (in the end, you can’t pay the mortgage with good feels). One major controversy surrounding ESG investing is the idea of sacrificing performance in the portfolio. Whether this is a reality can be hotly debated, but for an investor who wants to utilize this investment method, you’ll find that maximum returns are not their primary goal anyway—so the debate is null.
Consider the ESG investor the same way you would consider the conservative investor. A conservative investor is willing to sacrifice performance in exchange for a good night’s sleep. An ESG investor is stating the same, but for different reasons. In both scenarios, seek the best funds available within the client-directed parameters and explain that using the S&P 500 as a standard benchmark might not be an appropriate performance comparison. Consider drafting an investment policy statement (IPS), outlining the client’s goals—qualitative and quantitative—and referencing that document during reviews.
Where to Turn for Help
As with any other area in financial planning, if your client has a need that becomes too specific, consult with someone who can help. Fund companies are motivated to discuss their new products, and many are offering webinars with an open Q&A. A growing number of planners are educating themselves to be specialists in this topic—leverage your advisory groups to search out someone who’d be willing to assist. Industry expertise can also be obtained, sometimes at no cost. The Forum for Responsible and Sustainable Investing (US SIF) offers on its website everything from one-page ESG basics to full courses, as well as a designation.
ESG investing is a broad umbrella with a rapidly growing number of options, but you don’t have to be an expert to satisfy your client’s expectation. Whether in the end you choose to incorporate ESG funds or utilize another method to satisfy their goal, a well-directed conversation can open doors for both the client and your practice.
Angela Parker, MSF, CFP®, is a financial adviser with WGG Wealth Partners, a private wealth advisory practice of Ameriprise Financial Services LLC, in Roseville, Calif. Contact her HERE.
Disclaimer: ESG investing may increase risk due to the limitations and constraints involved in investment selection and, as a result, the fund may underperform other funds that do not consider the social impact. Investment advisory products and services are made available through Ameriprise Financial Services, LLC, a registered investment adviser. Ameriprise Financial Services, LLC. Member FINRA and SIPC.