Investor demand for ESG products is reaching new heights, and clear communication that transparently reports impacts, risk and returns is key to meeting clients' needs, according to ESG investing experts.
Michelle Brisbane, CEO of Ethical Investment Services, told the virtual audience at Financial Standard's Best Practice forum on ESG that the practice has expanded in the last 18 months to accommodate new demand for investments that deliver returns while aligning with environmental and social values.
This was backed up by consumer surveys, noted Nicolette Boele, executive manager, policy and standards, Responsible Investment Association Australasia (RIAA). Boele cited the RIAA From Values to Riches report which found that nearly 90% of respondents expect that their savings and superannuation is invested responsibly or ethically. That has translated into inflows over the past year.
"We've had an uplift in funds under management by leading responsible investment of 30% between 2019 and 2020," Boele said. "The proof's in the pudding - it's not just in intent, it's in behaviour."
Dimensional Fund Advisors head of Asia Pacific portfolio management Bhanu Singh noted that advisers are grappling with responding to client demand for ESG products while balancing out their fiduciary duty to produce best returns, and that there can be a trade-off to manage.
Singh took the example of greenhouse gas emissions, explaining that Dimensional's research shows that there is not a pricing advantage to investing in companies that have a better emissions profile when compared to similar companies with a higher emissions profile, and investing to screen out less sustainable companies can bring increased risks.
"If you put a constraint on a portfolio, you have to pay for it," he said. "It's not free. What we think happens is you get higher tracking error with respect to the benchmark. Some investors may be willing to bear that, because they care about sustainability deeply enough, or they care about reducing their exposure at least deeply enough, and others might not be willing to do that."
Brisbane noted that over the long term, the bespoke portfolios managed by her firm achieve market-like returns, explaining that Ethical Investment Services use active stock-picking approaches to investing for those portfolios.
"What we see over the long term is that the portfolios in really strong markets, perhaps they slightly underperform, but over the long term, we see that the returns are slightly above what the market delivers," she said.
There were a number of questions from the adviser audience at the event asking for guidance in how to conduct conversations with clients around ethical and ESG preferences.
Brisbane notes that when she has first meeting with clients, she conducts a risk profile questionnaire and an ethical profile to establish the activities they either want to support with their money or avoid with their money. Clients rank their preference on a scale of strongly agree, agree, or neutral.
"It's about transparency with the client as well, making sure that the client knows where the money is invested," Brisbane said. "For a long time, we've been totally transparent as much as we can be to provide information on the underlying investments. That builds quite a deep relationship and understanding about where they're at on the ethical side.
Dimensional convenes sustainability councils in countries where they operate to work with advisers on ESG-related questions, Singh said.
"The hardest part of the job to get clients to identify what sustainability means to them," he said. "The second piece is to understand the trade off they're making.
"... When it comes to running commingled strategies for advisers, for example, it becomes a more interesting issue, because you have to get a bunch of people to agree on a definition, which, especially when it comes to the social side of things, can be quite challenging. We have sustainability councils that we've set up around the globe to work with our clients."
Dimensional will then test the environmental and social considerations that clients are raising as issues to see if screening them out of portfolios negatively impacts on the overall performance, Singh noted.
Boele pointed to resources available to advisers, such as RIAA's financial adviser guide and the Responsible Returns website, a tool to allow consumers to search for responsible or ethical financial products that are certified by RIAA.