Investor’s inheritance, ESG concerns prompt her to switch advisors

This article appears in the May 2022 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

The situation

Jessica Park* (50) has never worried about her investments. The vice-president of an international development organization in Edmonton, most of her $110,000 salary goes toward her mortgage and her employer’s group RRSP, though she also has investment accounts through her bank brokerage. About five years ago, colleagues pushed for ESG options in their group RRSP and switched to a provider with funds they considered suitable. That prompted Jessica, who leads her organization’s gender equality division, to think more about her own investments.

At Jessica’s request, her advisor reluctantly moved her investments (a maxed-out TFSA, $90,000 in a personal RRSP and $30,000 in an unregistered account) into ESG funds. She now holds about $280,000 in those accounts, and her group RRSP account is worth $40,000.

Lately Jessica has been reading more about “greenwashing” and how the fund industry is a “Wild West” when it comes to regulating ESG claims. She reviewed the funds in her own accounts and found they hold some of the mining and arms companies she’s spent her career advocating against. There’s also a significant concentration of big tech companies she doesn’t support. (A single parent with two teenagers, she’s worried about the hold that devices have on her children.) She raised her concerns with her advisor and felt she wasn’t taken seriously.

When Jessica’s mother died this year, leaving her a $700,000 inheritance, Jessica decided it was time to switch advisors. What questions should she ask when interviewing prospective advisors? And what kind of investment choices might be available to someone like her with specific viewpoints on ESG?

*This is a hypothetical client. Any resemblance to real people is coincidental.

The experts

Pooja Gurrala Investment counsellor, Dixon Mitchell Investment Counsel, Vancouver

John Hastings Senior portfolio manager, Hastings Wealth Management, RBC Dominion Securities, Ottawa

Richard Nickerson Financial planning advisor, Assante Capital Management Ltd., Halifax

Answers have been edited for length and clarity

Discussing ESG

Pooja Gurrala (PG): It’s not hard to put together an ESG portfolio that aligns with Jessica’s values. The fact that she was snubbed is harsh, and it shouldn’t be that way. The most important thing is that she finds an advisor who takes her concerns seriously.

ESG can mean many things to different people. So I’d start by asking what her values are, what she is most passionate about, what her biggest concerns are and what she would like to see changed. Also, how does she think she can make a difference in respect to the concerns she has?

Richard Nickerson (RN): I would start by grouping the different ESG approaches into four categories and explaining each to her: exclusionary, impact, ESG integration and thematic.

The negative screening, or exclusionary approach, excludes specific sectors or companies from a portfolio, based on ESG criteria — for example, companies that produce tobacco products.

Impact investments make a positive social or environmental impact in addition to a financial return. The impact should be measurable. For example, how many tonnes of CO2 are saved annually by a company using energy-efficient technology? At its core, ESG is a risk mitigator. Impact investments consider ESG risks, but invest with a forward-looking, opportunistic lens.

ESG integration considers environmental, social and governance factors in the manager’s investment decision-making process.

Thematic investing considers investing in themes related to improving social or environmental sustainability, such as renewable energy.

John Hastings (JH): To incorporate these different strategies, you can use both passive and active tools. But in this situation, it’s difficult to find a passive fund or an ETF that hits all of Jessica’s objectives, so an active approach would be the most appropriate.

I would score companies based on their environmental, social and governance attributes. Then, identify those that are strong and those that are weak. Ultimately, you weed out the weak ones. She doesn’t want to be invested in mining or ammunition companies, for instance. So that would be a screen I’d apply on a portfolio level.

PG: Also, say she cares about the environment. There could be companies that have a great overall ESG rating because they’re ramping up their S and G. But maybe they are dumping garbage into the ocean, and that wouldn’t be OK with Jessica. So I would talk to her about digging deeper into ESG integration, really looking at the E, S and G separately to see that it aligns with her values.

RN: Funds can exclude particular sectors, such as oil and gas. Even though a fund may not hold an oil company directly, owning a bank lending to extraction-based projects and companies may not cut it for a client. It is up to the individual to decide the extent of the exposure. They should at least be made aware of the exposure to the sector they would like to avoid.

Divestment vs. engagement

PG: We, as a firm, believe in engagement. As shareholders, we have the opportunity to have a dialogue with management teams of companies to understand their ESG goals and be a part of making a difference, whether that’s through conversations or proxy voting. We make it clear to companies that ESG practices and their ratings will have an impact on how much we hold in our portfolios.

If you decide you don’t want to be a part of something, like a company that has some environmental concerns, then you end up limiting your investment universe. And you’re not taking other factors into consideration.

For example, we’re in an inflationary environment right now. You may not want exposure to energy, but I’d suggest having some energy in your portfolio with companies that are working toward ESG targets. Trying to exclude everything could have an impact on your goals because you’re not looking at returns and risk. More importantly, as far as engagement is concerned, the trade-off is that change happens more slowly without engagement. It doesn’t happen overnight.

Also, Jessica is worried about exposure to big tech stocks. I would probe to get more information on which big tech names she’s uncomfortable with. Is it social media names, like Facebook, where there are privacy and surveillance (not to mention the addictiveness) concerns, or is it big tech in general? I would then do an analysis to show her how her portfolio would have done without these names, especially [when they were leading] the pandemic recovery.

I would also present positive initiatives tech companies are part of. Apple, for example, has screen-time tracking, night mode and do-not-disturb mode for managing screen time. Google’s ESG initiatives include partnering with health-care companies to optimize clinical workflows. It recently introduced a new feature to Google Maps showing the most fuel-efficient route, and Google Flights shows carbon emissions.

The goal isn’t to change Jessica’s mind on big tech, but to give her information so she can make an informed decision on whether she wants to hold some names or exclude them completely.

Future planning

RN: Jessica should not incur tax from the inherited funds. However, she would be responsible for future investment income from the inheritance.

JH: We’re also thinking about the future use of those inherited funds. We need to understand her short- and long-term goals so we can better allocate these funds. I can imagine retirement in 10 to 15 years is top of mind for her, as well as having funds set aside for her kids’ education.

RN: Setting up an RESP and taking advantage of the Canadian Education Savings Grant would be the first step to set aside money for her kids.

PG: I would recommend a family RESP over an individual one. If one kid decides not to go to school, the income and earnings from that kid’s contributions can be used toward the one that goes to school. So that’s a benefit of having a family RESP over an individual one. We know the kids are in their teens, so that asset allocation needs to be treated accordingly because that’s a shorter time horizon than her retiring.

She should also maximize her RRSP room to have that tax-deferred growth. But we need to know if she expects her income to be steady or increase in the future. This will help determine whether we want to use the deduction now or later, when her income may be higher.

JH: Once she’s put money into an RRSP and RESP, she could put any remaining funds into a family trust. This way, she’d loan money to the family trust with the prescribed rate loan strategy. The children would be the beneficiaries and any investment returns would be taxed in their hands at a lower rate. It could wind up when they go to college or university, for instance, but the objective would be to provide for the kids’ extracurriculars or additional education expenses.

There is no minimum amount needed to establish a family trust, and proper planning would be done to determine how much income her kids may need now, and in the future, to cover these costs.

ESG questions prospective clients may ask

• How many years have you been helping clients align their portfolios with their social, environmental and ethical values?
• What percentage of your clientele consider their social, environmental and ethical concerns when investing?
• Are you a member of the Responsible Investment Association (RIA)? Have you attended any of their conferences?
• Have you taken continuing education courses regarding responsible investing, like the Responsible Investment Specialist (RIS) and Responsible Investment Advisor Certification (RIAC) designations from the RIA?
• Do you have proactive conversations with clients regarding RI?
• Do you have a pre-existing model to start from when it comes to ESG?
• What investments do you use that have a social impact?
• What are your financial planning designations?