How to Diagnose Client Motives for Sustainable Portfolios

Instead of an on-off switch, sustainable investing is a dial you can adjust to client goals for impact and risk-adjusted returns.

Investors are used to thinking about the trade-offs of sustainability in their everyday purchasing decisions. Would they pay more for water bottles made from recycled plastic? Do they power their house with solar panels?

As an advisor, you can help your clients navigate the opportunities and trade-offs of sustainable-investing strategies.

1. Using ESG factors to make smarter investment decisions.

Some clients want to pursue sustainable investing because they believe in its performance potential. They hope to invest in companies that will benefit from the move to a low-carbon economy or that proactively manage their exposure to environmental, social, and governance risks.

The recent Inflation Reduction Act promises to be the largest investment in climate action in U.S. history. The law aims to cut carbon emissions by 40% by 2030 and clean up pollution that threatens health in disadvantaged communities. Its passage spurred massive asset inflows into clean energy funds.

More cautious clients may want to understand how environmental and social risks could pose a threat to their holdings. Pharmaceutical companies that regularly hike prices on essential drugs could face risks from policy changes. Businesses that dump toxic emissions into their communities could also face financial risks.

The Morningstar Sustainability Rating quantifies how environmental, social, and corporate governance factors could affect shareholder value.

The 1-5 globe system rates companies and funds for their exposure to ESG risks and their efforts to manage them. A 5-globe rating indicates that a fund faces negligible financial risk from overall ESG factors. A 1-globe rating means a fund is exposed to severe ESG risks.

In Advisor Workstation, you can screen out funds with high sustainability risks or help clients compare the ESG risks of different portfolio plans.

2. Aligning client investment dollars with values.

In Schwab’s Modern Wealth Survey, 73% of U.S. respondents said that their values guide their investment choices. To your clients, this could mean investing in sustainable businesses or divesting from companies with practices they oppose.

For example, doctors who spend their days treating patients may want their investments to reflect their commitment to health and well-being. This client could align their investments with companies that earn revenue from sustainable practices, like producing affordable antimalarials in developing countries.

For this client, you could also exclude companies with a history of sustainability controversies. Clients can avoid pharmaceutical companies that sell unsafe products or hike their prices far above cost-effectiveness thresholds.

All sustainability decisions come with trade-offs. Filtering out funds with high ESG risk ratings could threaten portfolio diversification and limit investment options. To exclude companies with negative impact, you may surface investment vehicles with higher fees. Both approaches could affect investment performance.

You have an opportunity to be your client’s partner in navigating the trade-offs of impact investing. In a field beset by vague terms and greenwashing, clear and thorough explanations build trust.

3. Applying investments to improve the world.

Your clients might hope to tackle environmental or social issues by investing in companies they believe in. These investors want their dollars to flow toward sustainable advances, like equitable healthcare and medical breakthroughs.

The challenge for advisors is to capture these preferences and their relative importance. What is your client’s priority? What outcomes will leave them feeling satisfied?

Consider these questions to assess your client’s motivations:

• How do your clients prioritize maximizing returns, limiting ESG risk, and promoting positive impact?
• Do your clients feel strongly about any environmental or social issues?
• What trade-offs are your clients willing to make?
• How do your clients react to uncertainty and financial risk?

Coming soon in Advisor Workstation, the new ESG questionnaire can capture not just the issues your clients care most about, but how much. Psychometric assessments tap into more accurate data to help you customize portfolios.

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The term ESG-investing strategies folds complicated, often-competing criteria into one phrase. Murky terms have allowed greenwashing to take root and fostered confusion about the ethos behind sustainable fund options.

By focusing on just one sustainable-investing theme, like human health, advisors can break the investment lens into manageable pieces. Start by helping your clients understand how human health affects their investments, and how their investments affect health.

You can ease into larger sustainability conversations by talking about trending topics and how they influence your clients’ investments. What conversations are your clients having around the dinner table or on lunch breaks?

In Northern California, where wildfires trigger asthma attacks and hospital stays, you can talk to clients about recent events to unpack the relationship between their investments, climate change, and human health. If your clients are parents, you can ask if recent corporate controversies about toxic baby formula have shifted their investment priorities.

Taking the time to ask questions—and listen to the answers—can help you stand out from the competition. In one McKinsey survey, about 70% of respondents said that personalization is “highly important” to their banking experience.

Sustainability conversations assure your clients that you will champion their priorities and offer transparency on how you’ll do it.

Ask questions like:

• Do your clients volunteer with any organizations? What causes do they support?
• Do your clients donate to any charitable causes? Do they hope to include charitable giving in their estate plan?
• Where do your clients live? What sustainability issues affect their area?

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The Morningstar Sustainable-Investing Framework offers a continuum of approaches from “do no harm” to “improve the world.” You can propose any combination that works with your client’s blend of risk tolerance, financial goals, and values.

How clients feel about sustainability issues in theory might diverge from how they feel in practice. With what-if scenarios, you can help clients compare their current portfolio to one that incorporates sustainable-investing strategies.

Do they feel comfortable with the worst-case scenario of short-term returns? Are they willing to trade potential performance to divest from practices they disagree with?

1. Apply exclusions.

Help clients avoid certain industries, companies, or corporate controversies. If your clients worry about the human toll of climate change, you can screen out companies involved in fossil fuel or thermal coal production.

2. Limit ESG risk.

Control exposure to material risks that could damage company value. Morningstar Sustainalytics measures 20 material ESG issues fueled by over 250 indicators. As an advisor, you can help clients understand how much of their portfolio is exposed to health-related risk, for example.

3. Seek ESG opportunities.

Identify and pursue sustainability leaders or companies with improving ESG practices. If clients are passionate about climate change, you can help them explore companies reducing their carbon emissions.

4. Leverage active ownership.

Engaged asset managers can vote on shareholder resolutionsvote on shareholder resolutions and serve as proxy voters to improve corporate sustainability and performance. Through the ESG Commitment Level, you can assess the knowledge and experience of the asset managers who oversee client funds.

5. Target sustainability themes.

Focus on investments with targeted exposure to companies affecting long-term trends. As an advisor, you can help clients navigate opportunities in renewable energy or health-themed funds.

6. Assess impact.

Evaluate the direct and indirect social and environmental impact of underlying investments. Morningstar Portfolio Impact Metrics create a common measuring stick to assess how portfolios affect themes like climate action and basic needs.

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At a time when clients expect personalization, financial advisors can use sustainable investing to stand out from the competition. With independent research, advisors can guide clients to confident investment decisions.

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