ESG Investing in 2017: Three Things to Know

Advisors who ignore the advent of ESG investing could miss out on some serious returns in their client’s portfolios.

At Schroders alone, ESG engagements have increased from less than 100 in 2008 to nearly 500 last year in 33 countries globally, according to Schroders data.

“Client interest has increased and so has the demand for reporting on governance,” said Jessica Ground, global head of stewardship with Schroders. “Our chief executive, Peter Harrison, has identified this as one of the key strategic areas for Schroders and an area where, if we are doing this analysis, it can help us come to better investment decisions.”

Environmental, social and corporate governance (ESG) investing has been discussed for many years as the next big investing fad. The idea involves measuring these three central factors to determine the sustainability and ethical impact of an investment in a company or business.

Following in Schroder’s footsteps, below are three things advisors need to know about ESG investing.

1. Expect More ESG products in 2017

An increasing number of scoring, indexes and rating systems are emerging to support a growing ESG values and belief system.

Current benchmarks and indexes include the Calvert U.S. Large Cap Core Responsible Index, the Dow Jones Sustainability U.S. Index, and several others.

“As interest by investors rises, the supply of products will grow to meet the demand,” said Peter J. Creedon, CFP with Crystal Brook Advisors in New York.

Just this year both Morningstar and Schroders introduced new ways to rank and score ESG investments.

“I primarily use Morningstar's new integration with Sustainalytics, to consider the overall ESG score of a mutual fund or ETF,” said Justin Arnold, founder of WashPark Capital in Denver.

While the Morningstar Sustainability Rating raises awareness on how well mutual funds and exchange-traded funds manage risk and opportunities in the areas of ESG, the Schroders Fundamental Risk Score weights the most prevalent risk factors to investment performance over the long term.

“There’s six or seven individual scores that analysts have to input with ESG being explicitly one of them along with quality of the industry and quality of management,” said James Gautrey, CFA and portfolio manager with Schroders. “It then tallies an end score.”

For example, Nestle has a fundamental risk score of 3.2 and European chemical company BASF has a fundamental risk score of 5.2.

2. ESG related investments offer competitive returns

The perception has been that investing along ESG lines can cost a portfolio returns, but studies show differently.

Ten-year average annual performance ranged from 6.05 to 7.49 percent, compared to 7.31 and 7.35 percent for the S&P 500 and Russell 3000 indexes, according to TIAA Socially Responsible Investing Performance Analysis.

“ESG strategies can enhance shareholder value,” said Jimmy Lee, certified fund specialist and CEO of the Las Vegas-based Wealth Consulting Group, which has some $900 million in assets under management. “It makes sense that corporate governance and doing the right thing can increase your bottom line.”

Avoiding considering long-term investment value drivers, which include environmental, social and governance issues, is a failure of the fiduciary duty, according to a Fiduciary Duty in the 21st Century report.

“There is evidence that suggests ESG investing may be beneficial to long-term performance,” Arnold said. “As a result, it may be an advisor's fiduciary responsibility to integrate sustainability into the investment process.”

3. Expect More Clients to Inquire about ESG

Whether an advisor incorporates ESG-related investments or not, they should at least be aware of their potential impact and growing demand in the event of client inquiries, especially among millennials.

Some 87 percent of millennials reported that they would stay with a financial advisor who is communicating with them about an ESG investment style, according to a TIAA Global Asset Management survey of investors and advisors.

“Clients are demanding ESG investments that reflect their opinions about climate change, eating healthier and organically, religious beliefs, fossil fuel alternatives, decent living wages and supply chains that have sustainably sourced products,” Creedon said.

Investors born in the 1980s and 1990s are among the most active investors in ESG trends at 93 percent. That compares with 68 percent of Gen Xers and 51 percent of baby boomers who say that social or environmental impact is important when making investment decisions, according to the 2014 U.S. Trust Insights on Wealth and Worth survey.

Juliette Fairley is a business and finance journalist who has written four personal finance books for John Wiley & Sons and has written for major news organizations, such as The New York Times and The Wall Street Journal. She is a member of the American Society of Journalists and the New York Financial Writers Association and a graduate of Columbia University's Graduate School of Journalism. Juliette can be reached at [email protected].

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