Get Morningstar’s essential reading for financial professionals in Advisor Digest.
Back when I was a new financial advisor, a client asked me for help in divesting, or excluding from their investment portfolios, all fossil fuels, weapons manufacturers, and private prison companies. I was honest with them that I didn’t have experience in this area, but would do my best to research and implement how we could make this happen.
Now, it’s a major part of what I do for a living. And while the profile of sustainable investing has grown tremendously, I know that for many advisors, sustainable investing is still very much unfamiliar territory. Over the coming years, advisors who truly incorporate sustainable investing into their practice--and don’t just give it lip service--will see a business advantage over advisors who do not.
With this column, I'm kicking off a series on how advisors can incorporate or deepen sustainability in their businesses. I'll start here with the basics, exploring some of the confusing terminology and why advisors shouldn't get too caught up in it, and instead how to focus on why it makes business sense to incorporate sustainable investing into your practice and how your business can make an impact in the real world.
In upcoming columns, I’ll expand on the steps for advisors who want to build a sustainable investment practice for clients across income and wealth spectrums. I’ll also provide specific recommendations and strategies for deepening your work in these areas. The topics we’ll address are:
- What are your clients' financial and impact goals?
- Where are your clients' assets held and what investment options are available?
- How will you evaluate sustainable investments and avoid "greenwashing"?
- How will you apply sustainable investing strategies to client portfolios?
- Who will vote during shareholder meetings or engage in shareholder advocacy?
- How will you incorporate sustainability and impact goals into clients' charitable giving and redistribution plans?
- What communication strategies will you apply around sustainable investment service offerings so you can reach the clients you want to serve?
What is Sustainable Investing?
For now, let’s start at the beginning. I’m using the term “sustainable investing” intentionally because it encompasses ESG (short for “environmental, social, and governance”), socially responsible investing, and impact investing. But no article on sustainable investing is complete without a brief overview of terminology because, unfortunately, these terms aren’t currently used in a standard way within the investment industry. As an aside, as research for this column I reviewed a dozen articles from major asset management firms to understand how they define sustainable investing--and all used slightly different terms to communicate the same concepts. This can be incredibly confusing for advisors and investors who want to incorporate it into their portfolios.
Here's a quick summary of the commonalities. "ESG" investing integrates the environmental, social, and governance practices of companies as material risks to guide investment decisions. ESG investing relies on data and research for security selection and portfolio construction. "SRI" or socially responsible investing, focuses on excluding or including certain industries based on the ethical or moral values of investors. Shareholder engagement and proxy voting are other key features of SRI-based strategies. "Impact investing" traditionally refers to private sector investments outside of public markets, such as direct investments to benefit specific communities, small businesses, and burgeoning industries. Impact investing can also refer to public investments, with a focus on positive outcomes to the environment and society, usually within specific themes.
You can say that ESG data looks back, SRI focuses on present action, and impact investing aims to influence what’s possible in the future. And essentially, sustainable investing can mean one of those tools or any combination of all three.
Introducing a Framework for Incorporating Sustainable Investing Into Your Practice
Rather than getting tangled in terminology, what’s important is understanding your clients’ priorities and values, and translating them into investment strategies that help them reach both their financial and impact goals. The same can be said for advisors. It’s important to define your own priorities and values to translate them into business practices that help you reach your financial and impact goals. The most important step for advisors: Defining your why.
Ask Yourself: Why Do You Want to Incorporate Sustainable Investing Into Your Practice?
With any kind of change or investment of resources into your business, including your time, it’s important to clarify your goals from the start.
One reason for advisors to incorporate sustainable investing into their practices is the opportunity to grow your business. Although millennials are often credited with the surge of sustainable investing, investors of all ages want to align their money with their values, but many don't know how. Either they don't have access to sustainable investment options in their employer-sponsored retirement accounts, or they're unable to find an advisor who specializes in sustainable investment portfolios that take into account concerns that are meaningful to them. In addition, a growing number of young inheritors are also looking for help evaluating and investing in direct impact investments such as CDFIs, worker-owned cooperatives, and businesses led by BIPOC entrepreneurs.
Sustainable investing can also strengthen your value to clients. In an analysis of how U.S. sustainable investments fared in 2020, Jon Hale, Ph.D., CFA, head of sustainability research for the Americas at Morningstar, shared that sustainable funds have set annual records for the past five years in annual net flows into a growing menu of passive and active funds. In addition, sustainable funds outperformed non-sustainable fund peers in equity, fixed income, and other categories. Given the widespread myth that sustainable funds underperform conventional funds, even I was surprised to learn from Hale’s recap that 75% of sustainable equity funds finished in the top half of their category, and 43% finished the year in the top quartile of returns.
Outside of the business case for incorporating sustainable investing, your work can have a profound impact on the world at large. To conclude his 2020 recap, Hale shared a call to action: “The turbulent events of 2020--the global coronavirus pandemic, continued weather extremes, the movement for racial justice in the United States, and the U.S. presidential election--underscored the salience of sustainability concerns to investment managers and strengthened the rationale for end investors to invest in a sustainable way.” Through practicing sustainable investing, advisors can direct capital toward areas that align with their and their clients’ values and vision for a better future--and away from those that do not.
Reflect on the Impact You Want to Make Through Your Business
Just as investors get to decide the type of impact they’d like to have by incorporating sustainability into their finances, advisors can define the impact they want to make through their work. Reflect on why sustainable investing is important to you. From there, consider how you can translate your mission into actions. If your motivation for incorporating sustainable investing into your business goes beyond the business case, here are some questions and suggestions that can help get you go deeper:
- What are the issues that you care about and why?
- Do you want to advise clients on public ("Wall Street") investments, private ("direct") investments, or a mix of both?
- Will you recommend and advise on sustainable investments only, or both sustainable and non-sustainable investment options?
- Are there specific themes (for example, environmental sustainability, racial justice, gender equity, animal rights) where you want to focus your recommendations for clients?
- Are there specific geographies (such as global, country or state-specific, local, and so on) where you want to focus your recommendations for clients?
- Are there specific communities (for example, Native businesses and communities, BIPOC entrepreneurs and leaders, women, LGBTQ+, and so on) that you want to support through your recommendations for clients?
- Do you want to participate in shareholder engagement and/or vote proxies for clients?
You can be as general or as specific as you’d like in your responses--it’s your business. Your responses to these questions can be crafted into a mission statement you can share in conversations and on marketing materials, including your website and client newsletters.
Next Steps for Building a Sustainable Investment Advisory Practice
In your conversations with prospective and existing clients, be honest about where you are in your sustainable investing journey--even if you’re in the beginning stages. Ask clients with traditional investments if this is something they would be interested in and what questions they might have about sustainable investing. And be sure to share what you learn with clients. This builds support in advance for any new offerings as well as showing that you are always learning. With a topic as complex and exciting as sustainable investing, clients will value learning alongside their advisor.
Defining your impact goals as an advisor creates a strong foundation. In my next column, I’ll explore how to help your clients clarify and define their financial and impact goals.
Phuong Luong, CFP, is an educator, financial planner, and investment strategist focused on economic justice and closing racial wealth divides. She is currently the investment strategist for Adasina Social Capital and the founder of Just Wealth, a virtual, solo, fee-only Registered Investment Advisor. She is also the online facilitator for the Boston University Financial Planning Program and a subject matter expert in ESG and regenerative investing. The views expressed in this article do not necessarily reflect the views of Morningstar.