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With more investors becoming interested in responsible investing, advisors should be equipped to answer challenging questions about ESG. And before selecting an ESG-integrated investment for a client, advisors should ask themselves these three key questions.
Is it the right match?
Advisors should first determine what a client is looking to achieve. Do they want to avoid investing in industries such as tobacco or weapons, or are they looking to proactively invest in a product that makes a positive impact on sustainable factors conditions or corporate governance? Or are they investing in a product that considers material ESG risks and opportunities with the sole objective of maximizing risk-adjusted returns?
Once you have that information, you can gauge what a potential product does and does not do and how it aligns with your client's investment goals. Four strategies that address these concerns are:
ESG integrated strategy: This approach incorporates ESG factors into investment decision-making to identify potential risks and opportunities with the goal of improving the client's long-term, risk-adjusted returns.
Impact investment strategy: This take involves investing in assets that intend to generate a measurable positive social or environmental impact alongside a financial return.
Socially Responsible Investment (SRI) strategy: This is an investment approach that generally applies an exclusionary or best-in-class approach to the investment universe based on a defined set of ESG-related criteria, generally stemming from a certain principle or set of values. These screens can be negative or exclusionary, as in the example of excluding weapons or tobacco companies from the investment universe; positive (best-in-class) or both.
Thematic investing: This method invests in assets involved in a particular ESG-related theme, such as fossil-free fuels. It can also fall under SRI, such as investing in a product that addresses a specific social issue, such as gender diversity.
How does the fund incorporate ESG?
After finding an investment that aligns with a client's needs, an advisor can then conduct the proper research and due diligence on a product, checking its mandate and objectives as laid out in the prospectus. For example, if a product mandate states only that it considers ESG factors, then it may not be appropriate for a client who is looking for an SRI strategy that includes or excludes companies based on a specific set of ESG criteria.
A closer look at what tools the asset manager uses to integrate ESG factors can provide advisors with useful context to their approach. For example, is there a specialized in-house team at the asset manager conducting ESG research and analysis to support integrating material ESG factors into their investment decisions? Advisors should also consider to what extent the product relies on third-party providers to analyze factors and if the product relies on ESG ratings from these providers. In addition, advisors can consider which providers are used.
You may also want to consider whether the product is actively or passively managed. A passively managed product incorporating ESG factors may track an ESG index, which the advisor should also investigate to determine if it is suitable based on the client's goals. In such cases, the passive manager may be more reliant on third-party providers to conduct sustainability assessments, whereas an active manager may rely more heavily on its own ESG assessment.
What is the fund manager's approach to stewardship?
The third question to ask yourself before selecting a product that considers ESG factors for your client is the extent of a fund manager's stewardship. Most applicable to equity investments, find out if the asset manager is energetically exercising their rights as shareholders by conducting thoughtful proxy voting to convey its views and expectations to boards and management on ESG issues.
Advisors can see whether an asset manager uses its own custom proxy voting guidelines, those of a proxy advisory service provider or another approach, and what role proxy voting plays in the manager's overall stewardship activities. Our view is that managers should engage with companies on material ESG factors such as climate change, cyber security or gender diversity to better understand how they are addressing their ESG risks and opportunities and, if necessary, request that companies take certain actions on ESG factors. Advisors should take into account that engagement opportunities differ depending on the asset class and sub-asset class a product is invested in. For instance, as owners, equity investors in corporate securities may have different opportunities to engage compared to a bond holder.
In a quickly evolving responsible investment landscape, a patient and careful approach to reviewing ESG products, and a manager's approach to ESG, can better position advisors to meet client goals. Before selecting an ESG investment on behalf of your client, ascertain their goals, and then do your research.
