As we work to help our clients build investment portfolios that promote a promising financial return, we also are seeing an increase in the number of clients who are interested in the content of those investments. Bloomberg reported that an estimated $120 billion was spent in ESG (environmental, social and governance) investments in 2021, and the sector appears to be on an upward trajectory in the years to come. To provide our clients with the most informed advice, it’s important that we as advisors are knowledgeable on this growing trend and can guide our clients on the opportunity to invest ethically.
What Is An ESG And How Does A Stock Become One?
An ESG investment is a stock that is rooted in values relating to environmental, social or governance issues, such as climate change, human rights, and data protection and privacy. For a stock to qualify as an ESG, it must undergo a rigorous evaluation process and adhere to certain principles set out by investment houses.
If the stock passes the initial evaluation, it is then scored based on the MSCI ESG index. ESGs can fall under three different categories in the U.S.: AAA-AA: Leaders, A-BBB: Average, and BB-B-CC: Laggard. This index rates organizations based on their exposure to ESG risks and how they manage those risks, and then assigns them one of the three categories above.
However, as I learned from a fellow MDRT member in the United Kingdom, work still is being done in the standardization process of ESGs, and these principles and ratings may vary from one nation to another.
Getting Started With ESG Investing
While millennials were the early adopters of this type of investing, it’s no longer exclusive to this generation. Older generations are becoming increasingly aware of ESGs and are expressing interest in incorporating ethical investments into their portfolios. In addition to getting kudos from their children and grandchildren for their conscious investing, clients feel as though they are helping make the world a better place without having to undertake a large social initiative.
For clients who are new to ESG investing, it’s important to review their portfolio with them in order to understand their passions and values that can translate into ethical investing. From there, I like to share available investment opportunities that align with those and see how we can incorporate them into their portfolio while also mitigating risk. Although ESGs do not carry any more inherent risk than do non-ESG investments, maintaining your client’s financial well-being should always be top of mind. To quell any fears about the financial return of ethical investing, I tend to invest only a small percentage of their portfolio, typically 10%, into stocks of this kind.
Finally, I like to look at the remainder of their portfolio and point out any possible conflicts of interest. For example, I had a client who did not want any investments in coal mines; however, one of their investments had an indirect relationship with funding coal mines. Although they ultimately decided to keep the stock due to its performance, it’s important to take a holistic approach when reviewing a client’s portfolio in order to provide them with full transparency and the best possible guidance.
Best Practices For Advising On ESGs
Every client’s degree of knowledge and comfortability with ESGs will vary, but ensuring you are educated on the topic and able to thoroughly discuss ESGs with your clients is essential. And while some clients are novices to the topic, I work with a sizeable number who solely invest in ESGs. These clients have a zero-tolerance policy for any investments that do not align with their values or efforts toward the betterment of the planet.
I recommend that advisors take the following steps before discussing the topic of ESGs with a current or prospective client. First, do your homework. I advise that you speak with a couple of the fund managers you work with and learn what types of ESG investments are currently available in a few different focus areas. Additionally, be sure to ask them what their screening criteria is and how they determine which stocks qualify as ESGs. Second, provide educational resources. While some clients are OK with investing 10% of their portfolio right away, others may need more research to make their decision. Putting together a one-pager that outlines the basics of ESGs and why they might be of interest to your client is a great way to not only show that you’ve done your research, but it also serves as an educational keepsake for your clients to refer to.