The ESG Revolution

The times are a-changing, the tables are turning. Investor concerns, which have long taken a back seat in the retail asset-management process, are gaining momentum. Wall Street is at long last being prodded, to an admittedly still-small measure, to address the concerns of those they serve. Slowly, the asset-management industry is conceding a fact it has long denied: It’s the investor’s money and it’s the investor who deserves to call the shots.

We’ve already witnessed a power shift in the flow of monies in the retail investment world. Thirty years ago, assets went almost as readily to high-cost funds as to low-cost ones, to ones with good risk controls as to those with poor ones. Today, that’s no longer the case. Now, assets flow to funds with better practices and lower fees. Investors and their advocates (financial planners, the press, and regulators) have demanded better value from fund companies— and fund companies, to their credit, have responded. Where once retail funds were sold, not bought, and assets went to those firms with the biggest salesforces or marketing budgets, today assets flow to those firms that serve investors best—ones that create better investor outcomes. The industry is more a meritocracy, rather than the marketing machine it once was. In the process, the investor has been raised from the lowly position of consumer (buyer beware!) to the elevated status of owner. It’s a nobler structure.

Defining investors as owners is a necessary precondition for the building sustainable-investing revolution. We now see growing investor power playing out in concerns that go beyond transparency and lower fees. Investors deserve this better treatment, and as owners, their rights go still further. After all, it’s their money. They have a desire and a right to know the impact their investments have on the world at large. They deserve a voice in the environmental, social, and governance, or ESG, implications of their investments—and they are beginning to get it. One of the great untapped benefits of managed funds is their potential to consolidate and amplify the voices of small investors, so that they are heard in corporate boardrooms. For too long, individual investor concerns have been conveniently ignored. Now through ESG offerings, they are starting to be heard.

What’s exciting about the ESG movement is that it’s a market-led revolution, not some government office imposing its view of which concerns should be addressed. As the information flow improves, investors will have greater ability to isolate their particular environmental and social preferences and vote with their hard-won savings for those practices they wish to support or suppress. Governments, of course, will play a role in shaping and enforcing many practices, but a market-led solution is a valuable and necessary counterpart. Markets are responsive and creative. They give voice to participants in an efficient fashion. Making markets a part of the solution leads to better outcomes. In an era when Congress refuses to reach across the aisle, it’s refreshing to see this blended solution: market-driven techniques addressing progressive social concerns.

Information enables this process. Admittedly, sustainability research is in its early days. Many of the measures are still crude. Much-needed information remains unattainable. But that will change as a new breed of investor/owner demands it. Moreover, we are already seeing asset managers jump on the ESG train, bringing many more talented minds to bear on these issues. This new breed of professional will demand and develop better data. We’ll see more distinct types of ESG investing emerge. We’ll see clearer standards given to corporations and more efforts on their part to meet these newly articulated demands. The process won’t be perfect, and there will be attempts to manipulate outcomes, but the general direction will be toward greater accountability and better expression of owner interests. At a minimum, a dialogue will emerge as the long-marginalized voice of the small investor begins to be heard. And as the quality of data informing the discussion improves, the debate will grow more sophisticated and impactful.

Fund companies will respond out of self-interest, not the goodness of their hearts, but they will indeed respond, as we’re already seeing. They will hire and promote people for whom ESG mandates are vitally important. In doing so, they will alter the DNA of their firms. Similarly, corporations will create positions to address the ESG concerns now being voiced by their shareholders, and those new employees will influence thinking and, in time, become senior leaders at those firms. What starts with a small step can become a significant movement. The key is getting the roles right, and it starts at the top—with the investor as owner. Investors as owners demanding new types of funds, asset managers articulating and relaying ESG concerns to corporations, and companies altering and improving their behavior all stem from the important first step of investors asserting their rights as owners, rather than passively taking what Wall Street offers.

ESG is part of a powerful transformation that’s already under way in the investment world. It’s an opportunity for the financial-services industry to make a positive contribution to society, to more fully serve a fuller range of its clients’ needs, beyond its already noble role of enhancing the individual security of savers. It is a window for the maturation of financial-services firms into a more fully integrated part of their clients’ lives. Much as the independent RIA community has morphed from being investment advisors to serving as life coaches, so too can the wider investment industry become something more significant, more impactful than what it’s been. It is an opportunity for growth for clients, advisors, and the investment industry alike.
Long live the revolution!

This article originally appeared in the October/November 2018 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.