Build your credibility with ESG

Here’s why you should integrate ESG criteria into your investment selection process — and how to do it.

Screening investments for environmental, social, and governance (ESG) criteria is “table stakes” for today’s advisors, says Matthew To, Senior Director of Business Development for Investments at Beneva. He argues that having the right tools in place, including client-driven socially responsible investment (SRI) policies, can also be an effective way to build your practice.

“A lot of millennials are very interested in investing in ESG. So, as an advisor, it’s easier to capture that market when you’re able to position an ESG solution in an intelligent way,” says To. “There’s a growth aspect as well, because ESG entails investing in renewable energy, [and] companies that are involved in carbon capture, electric vehicles, and wind and solar farms — anything that helps us progress toward a zero-carbon economy — are growing enterprises.”

Today, ESG is mainstream among institutional investors. In fact, To points out that almost every Canadian is already an ESG investor because the Canada Pension Plan applies ESG analysis to all of its investments. It’s also so core to the operations of large businesses that about three in four S&P 500 companies tie executive compensation to ESG performance.

Furthermore, it’s increasingly recognized that demand for renewable energy is being driven by the private sector — for example, by technology companies that want to move away from fossil fuels —rather than government incentives. To says this “sustainable appetite” stands to benefit ESG investors and the advisors who guide them toward appropriate investments.

ESG screening helps to mitigate risk

While attracting clients and uncovering investments with attractive long-term growth potential may be the flashy side of ESG integration, risk mitigation through ESG investing is probably even more important to build a practice that is successful over the long term. 

As a case in point, in 2022, one of the largest U.S. natural gas and electric utilities agreed to pay more than US$55 million to escape criminal prosecution for two disastrous California wildfires because its power lines were implicated in the blazes. 

“If you had ESG baked into your approach, then this is a company that may have been screened out because of these unsafe power lines,” To suggests, emphasizing that the US$55 million was a drag on the company’s performance and therefore investors’ returns. 

In general, companies that take ESG seriously tend to be more transparent with their investors, he adds, often disclosing more details about their operations than what’s strictly required from public companies. More information helps investors mitigate risk and gives them greater confidence in investment decisions.

Of course, not everyone is equally transparent. Greenwashing — when a company or fund manager pretends to be greener than it is — still happens. For example, a German asset management company recently paid US$25 million to settle U.S. Securities and Exchange Commission charges stemming, in large part, from misstatements concerning the firm’s ESG investment process. Again, a significant cost to the company diminishes investors’ returns.

“It’s important to address greenwashing [and] to ensure there are standards and disclosure requirements for fund managers,” says To.

Design investment policies around client priorities

Integrating ESG into your practice starts with client conversations. 

As part of the discovery process, To says advisors can probe to find out if investing in environmentally friendly companies or companies that have fair labour practices connects with a client’s values. Then, in ongoing client meetings and through financial literacy workshops, they can introduce ESG concepts, aided by illustrations like the ones available through Visual Capitalist.

“Having an earnest conversation with clients is the first step. If ESG values are important, then you can move to the next step and start screening managers for their ESG adherence,” he says.

ESG investors generally expect two things from ESG investments: a social impact and a financial impact.  

To measure the social impact, advisors can check a fund’s holdings against ESG ratings set by MSCI, S&P, and Sustainalytics, which scour the web for corporate data and other information — such as news articles — about a company. It’s a good signal when the vast majority of the fund’s holdings rate highly. 

To measure the financial impact — in other words, the effect on returns — advisors can measure a fund against a benchmark. ESG screening of a fund’s holdings should have a material impact on financial performance against a peer group. Ideally, it will also help to diversify a client’s portfolio. 

Now you’re ready to match specific funds to a client’s investment policy statement, and then clearly communicate social and financial results through customized ESG reports. 

“A best-in-class SRI policy [which considers financial returns and ESG benefits] goes beyond the surface-level aspects of ESG and strives to create a meaningful and measurable impact on society,” says To. “It’s important for advisors to really go into the weeds with clients. Being specific on what they want to accomplish is key.”