To highlight the differences between ESG funds, it’s helpful to think about dogs.
For those who don’t immediately conjure an image of a Golden Retriever, maybe a teacup Chihuahua comes to mind — or perhaps a St. Bernard. And there are far too many types in between to even consider listing, let alone the category of mutts, who are infinitely variable in appearance and charms.
While “dog” refers a species — canis familiaris — it doesn’t say much about an animal’s size, color or personality.
Meanwhile, one fund with “ESG” – or environmental, social and governance – in its name might be virtually indistinguishable from an S&P 500 Index fund. Another could exclude certain companies or industries. The term might also pertain to an impact fund that puts social or environmental goals slightly ahead of financial returns.
Add to that the recent political attacks on ESG that have charged the broad category with everything from hurting investors’ returns to quietly reshaping industries and threatening democracy. Defenses of ESG have been that it can help financial performance, that it can assist in putting the world on a course for sustainability and that it is simply a category of data that fund managers use to assess risk and opportunity.
It has come to mean so many things that it isn’t necessarily a helpful descriptor.
While there are plenty of financial advisors who see benefits in sustainable investing, or at least the use of ESG criteria, those who are leery of ESG are not alone.
“It is bizarre that we continue to use one term, ESG investing, to describe what in reality is a variety of different investing objectives, priorities, strategies and outcomes,” said Lisa Sachs, director of the Columbia Center on Sustainable Investment. “It leads to mass confusion. And it’s that confusion that is then opportunistically abused in these shenanigans and culture wars. It’s absurd, but it’s playing on the confusion.”
Because most of what is referred to as “ESG investing” has nothing to do with sustainability outcomes, Sachs said she wouldn’t encourage advisors to pursue funds on the basis of being packaged as ESG products.
“The products are not clear on whether they’re meeting those objectives. I sympathize with anyone expressing reluctance about this space,” she said.
CHANGING PREFERENCES
Advisors’ views on ESG can be complicated. Data from surveys show that while advisors generally use sustainable funds sparingly, preferences are shifting, both for and against it. About a third of more than 400 advisors surveyed last year by the Financial Planning Association said they include “ESG” in clients’ portfolios. More than a quarter, 28%, said they planned to increase their use over 12 months, and another 15% said they anticipated cutting back.
Separately, data from Cerulli Associates show two-thirds of advisors consider ESG factors for clients, although 70% said they allocate less than 6% of assets to ESG-focused or sustainable products. However, advisors last year told Cerulli that they expected to increase use of those products over two years, with 36% allocating between 6% and 10.9% of assets, and another 17% putting that figure at between 11% and 20%.
Additionally, more than half, 56%, said they have discussions with clients about ESG, said Michele Giuditta, director of institutional at Cerulli. However, of those advisors, 77% said they wait for clients to inquire, meaning that few actively broach the subject, Giuditta said.
Increasingly, politics appears to be a factor. While asset managers most often point to ESG considerations as ways to assess financial risk and opportunity, that line of thought has questioned by Republican state leaders and members of Congress.
“Every year, we ask advisors a whole host of questions on hurdles to adoption,” Giuditta said. What stands out is an increase over the past year in those who say ESG is politically motivated, she said.
“The big change occurred when we started seeing the bulk of these [state] ESG bans that were put in place last year — and this year as well,” she said.
The Republican effort against ESG might be encapsulated by a series of hearings and bill markups held in July, in what members of the House referred to as “ESG month.” Currently, there are numerous pieces of legislation that seek to curb the use of ESG factors in the financial services industry, although few, if any, stand much chance of getting through both sides of Congress this year.
Anecdotally, advisors’ stances on ESG are also politically aligned. Research calls Cerulli has held with advisors show that the highest acceptance is on the liberal-majority coasts, Giuditta said.
And the financial advice profession might skew Republican. A survey last year by InvestmentNews found that 60% of advisors said they would prefer Republicans to control Congress in 2023, versus 25% who said they would rather have Democrats leading, with the remainder saying they were unsure or would like control to be split between the parties.
ADVISOR PERSPECTIVE
Katherine Edwards, a financial planner at MainStreet Financial Planning, loves “the heart and motivation behind ESG and sustainable investing” but cautions clients to do their homework on such products. One group, responsible investing advocate As You Sow, has a site that compares the underlying holdings of mutual funds — and users can screen products for exposure to fossil fuels, weapons and other areas.
“Most normal people are going to see the ad that this ESG fund is helping save the world, but they don’t have the time to look and see if that’s true,” Edwards said.
ESG-themed funds often hold 90% of the same stocks as their conventional counterparts, but investors pay a premium for what purports to be a more sustainable product, she said.
One client who came to her had a portfolio composed almost entirely of ESG-themed funds, although the client didn’t realize many of the funds’ top holdings were tech stocks and that she had some exposure to oil companies. Edwards suggested a handful of different sustainable funds that most closely aligned with the customer’s values.
But another way of addressing sustainability preferences is asking clients whether they’d be better off using some of their assets to put solar panels on their homes or buy an electric car, she said. Discussions about ESG can also cover giving, if clients are charitably inclined, Edwards noted.
That could be a good strategy for someone with shares of an ETF they no longer want to hold because it conflicts with their values – there can be no taxes on the gains for shares that are donated, she said.
Someone who said he found screening processes for ESG-themed funds “arbitrary and political” is Scott Bishop, cofounder of Presidio Wealth Partners.
“I have never purchased or used an ESG Fund, SMA or ETF for any clients,” Bishop said in an email. “I felt that the ESG agenda could find money flows, but the way Wall Street started with mediocre funds ‘rebranded’ as ESG Funs, I was suspicious of execution.”
His advice for people who want ESG: “Make sure you do your research on the sector and ideas. Know the fund managers screening process and make sure the overall idea will be able to eventually find profits, growth and/or at least a gain in market share.”
ON THE FENCE
As the creator of the College for Financial Planning’s Chartered SRI Counselor program, Jennifer Coombs doesn’t regularly cross paths with advisors who are outright opposed to ESG.
But at a time when the topic has become politically charged, opponents aren’t to change their minds about it, Coombs said.
“It doesn’t matter how many studies you stick in front of them. They still think that it harms performance,” she said.
What’s important to know, especially for those who are on the fence about ESG, is that “it’s meant to be a long-term strategy,” as sustainability-themed funds will have periods of outperformance and underperformance, Coombs said. “It’s not meant for day traders. It’s meant for 401(k)s and IRAs.”
What all advisors should consider is that some clients will want ESG factors used in their portfolios, and professionals need to know enough about the topic to properly guide them, she noted. For example, categories like values, integration and impact have different levels of conviction on ESG criteria.
“They need to recognize that they can help clients [who are] interested in the ESG space, but understand that they are not all the same,” Coombs said. “Clients themselves might need some help understanding where they stand in that [ESG] spectrum.”
The political attacks on ESG have had consequences, and some firms have become hesitant to even mention that they can advise clients on it, she said.
One company she is working with on an ESG training program is doing so because the team wants to have a knowledge base, rather than because they intend to specialize in sustainability, she said. But “it’s not something that they want to advertise that they have knowledge about.”
That trend, which has come to be known as “greenhushing” is the opposite of the better known greenwashing problem.
FROM AMBIGUITY TO GREENWASHING
The Securities and Exchange Commission requires funds to invest 80% of net assets in accordance with their names — but that leaves 20% that a product, such as a sustainability-themed fund, could potentially hold in securities that have nothing to do with sustainability, Sachs said.
The SEC has proposed a rule that would help clarify an “ESG” fund’s practices, such as whether it merely integrates ESG considerations or if it is a full-on impact fund.
“No one on the planet would be more of an advocate for aligning finance with sustainability than me,” Sachs said. “I find it very hard to do that in this current environment, because of these vastly different strategies, approaches and goals.”
A recent report from the Columbia Center on Sustainable Investment that addresses the confusion over ESG in financial services offers several recommendations for the industry: Be clear about climate commitments, targets, metrics and methodologies; stop any anti-climate lobbying; focus on the real economy rather than portfolio emissions; and strengthen accountability and oversight.
Despite numerous studies on performance, Sachs said issues such as methodologies varying widely and many ESG-themed funds being 99% the same as conventional ones mean that it’s hard to draw conclusions.
“It’s a silly thing to say that ESG is necessarily good or necessarily bad,” she said. “But it’s insane to tell any investment manager to distinguish some risks from other risks … Do the Republicans really want to tell investors to not consider flood risk?”
But until there is more consensus, it would be a mistake to ignore ESG, as interest in sustainable investing is only increasing as younger generations amass wealth, she said. More students have also been preparing for careers in sustainable finance, she noted.
“The asset owners — everyone from the retail investors to institutional investors — have and will have an increasing genuine interest in different versions of ESG investing … The absolute risks of climate [change] and systemic risks to their portfolios are impossible to ignore,” Sachs said. “It would be very misguided for financial advisors to not understand these issues.”
[More: Political uncertainty steering 401(k)s away from ESG]