How To Talk With Your Clients About ESG Investing (2023)

ESG investing is a growing trend among investors who want to better align their money with their values. ESG stands for environmental, social, and governance, and it refers to a set of criteria that evaluate how a company performs on these aspects. ESG investing can help investors achieve both financial and non-financial goals, such as supporting social causes, reducing environmental impact and promoting ethical business practices.

Around 89 percent of investors factored ESG issues into their investment strategies in 2022, according to research by Capital Group. This means that it is no longer a niche market or passing fad. Moreover, clients today are demanding more and better ESG information and services from their financial advisors.

So how can financial advisors approach the topic of ESG investing with their clients? How can they explain what ESG investing is, assess whether it is suitable for their clients, address common misconceptions and create personalized ESG investment strategies? In this article, we will provide some tips and insights on how to have effective conversations with your clients about ESG investing.

Key Takeaways

ESG investing, which prioritizes investments that positively promote environmental, social, or corporate governance issues, has grown to become a substantial segment of investable assets.
Clients, especially those 40 and younger, often bring up ESG investing with their advisors.
Still, many financial advisors are reluctant or unsure about how to talk about ESG investing with clients.
Here, we provide some background and advice for financial advisors to include in discussions of ESG investing when meetings with clients.

Defining ESG Investing to Your Clients

The first step is to define what ESG investing means and why it matters. You can use the following points to introduce ESG investing to your clients.

ESG investingis a strategy that considers environmental, social, and corporate governance factors in addition to financial matters when making investment decisions. It aims to invest in companies that have positive impacts on society and the environment, while avoiding those that have negative impacts or pose risks.

ESG investing can benefit both investors and society. For investors, ESG investing can help them align their money with their values, support positive change in the world, diversify their portfolio, reduce risk and enhance returns. For society, ESG investing can encourage companies to adopt more sustainable and responsible practices, which can improve their long-term performance and contribute to solving global challenges.

Environmental factorsinclude how a company manages its natural resources, reduces its greenhouse gas emissions, adapts to climate change, minimizes its waste and pollution, and promotes renewable energy and clean technologies.
Social factorsinclude how a company treats its employees, customers, suppliers and communities. This can involve issues such as diversity and inclusion, human rights, labor standards, health and safety, customer satisfaction and social responsibility.
Governance factorsinclude how a company is run by its board and management. This can involve issues such as executive compensation, board diversity and independence, shareholder rights, business ethics, transparency and accountability.

Is ESG Investing Right for Everyone?

The next step is to assess whether ESG investing is right for your clients. ESG investingis not a one-size-fits-all approach and might not be appropriate for everybody. It depends on your clients’ investment goals, personal values, beliefs, and priorities. Some clients may care more about certain ESG issues than others, or have different views on what constitutes a positive or negative impact. For example, some clients may favor renewable energy over fossil fuels, while others may prefer nuclear power over both.

ESG investingrequires specific research and due diligence, and not all ESG investments are created equal. There are different ways to measure and compare ESG metrics and performance across companies and industries. Several financial companies today score and rank companies based on their ESG performance, but each rating company has a different approach to scoring. Be sure to use evaluations that align with your clients' goals.

If your clients do seem interested in ESG investments, it's also important to discuss the pros and cons

ESG investingis not a substitute for holistic financial planning. It is important to consider your clients’ overall financial situation, needs and objectives when designing an ESG investment strategy. You should also review your clients’ portfolio regularly and adjust it as needed to reflect any changes in their circumstances or preferences.

Discussing Benefits

Here are some positive factors to consider when discussing ESG investing with your clients:

Potential for competitive returns: Research suggests that ESG investments can perform as well as, or better than, traditional investments.
Risk mitigation: ESG factors can help identify and mitigate potential risks associated with poor governance or environmental and social issues.
Long-term perspective: ESG investing encourages a long-term outlook, focusing on the sustainability and resilience of companies.
Diversification: ESG investments can provide additional diversification within a client's existing portfolio.

Discussing Concerns

Here are some potential concerns or drawbacks to consider when discussing ESG investing with your clients:

Lack of standardized reporting and metrics: One major concern surrounding ESG investing is the absence of universally accepted reporting standards and metrics. This lack of standardization can make it difficult for investors to compare companies' ESG performance and make informed decisions. ESG investing is subject to regulatory changes, as governments and international organizations work towards establishing more standardized ESG reporting and disclosure requirements. Investors and financial advisors need to stay informed about these changes to ensure compliance and adapt their investment strategies accordingly
Greenwashing: Some companies might engage in "greenwashing," which refers to the practice of overstating their ESG efforts in order to appear more environmentally or socially responsible than they truly are. This can mislead investors and undermine the credibility of ESG investing. Indeed, recent reports about companies publicly embracing ESG as a cover for poor business performance or financial practices have alarmed some investors and analysts.

Limited investment universe: By screening out certain companies or industries based on ESG criteria, investors might reduce the pool of potential investments. This limitation can lead to a less diversified portfolio and potentially higher concentration risks.
Higher fees: ESG funds and products can sometimes come with higher management fees compared to traditional investment products, as they require additional research and analysis to assess companies' ESG performance.

Common Client Misconceptions About ESG Investing

Once you've evaluated your clients' suitability for ESG investing and discussed its potential pros and cons, you may want to address some common client misconceptions about ESG investing. You can use the following points to clarify some myths and facts about ESG investing:

Myth: ESG investing is only for younger generations or environmental activists.

Fact: ESG investing is for everyone who cares about the impact of their money on the world. While younger generations like millennials may be more interested in or aware of ESG issues than other demographics, they are not the only ones who value ESG investing.

Myth: ESG investing is only for wealthy or institutional investors.

Fact: ESG investing is increasingly accessible and affordable for all types of investors. Thanks to the growing availability and variety of ESG products , such as mutual funds , exchange-traded funds (ETFs) , mutual funds, and roboadvisors. Investors today can choose from a wide range of options that suit their budget and preferences.

Myth: ESG investing is only for certain sectors or industries.

Fact: ESG investing is applicable and relevant for all sectors and industries. While some sectors or industries may have more exposure or influence on certain ESG issues than others, no sector or industry is immune to ESG risks or opportunities. For example, even though the energy sector is often associated with high environmental impact, it also has the potential to contribute to the transition to a low-carbon economy by investing in the development of renewable energy and clean technologies.

How to Create a Personalized ESG Investment Strategy

Creating a personalized ESG investment strategy involves several steps that can help you align your portfolio with your values and goals. Here are some tips on how to go about it:

Define your ESG preferences and priorities: The first step is to identify what ESG issues matter most to you and why. You can use various sources and tools to help you assess your ESG preferences and priorities, such as online surveys, questionnaires, quizzes or frameworks.For example, you can use the 17 UN Sustainable Development Goals (SDGs) as a reference point to select the social and environmental themes that you want to support with your investments.
Assess your risk tolerance and return expectations: The second step is to determine how much risk you are willing to take and what kind of returns you are looking for with your ESG investments. You should also consider your time horizon, liquidity needs and tax implications. You can use various sources and tools to help you assess your risk tolerance and return expectations, such as online calculators, simulators or planners.
Choose your ESG approach and products: The third step is to choose how you want to incorporate ESG factors into your portfolio and what kind of products you want to invest in. You can use various sources and tools to help you choose your ESG approach and products, such as online databases, platforms or advisors.For example, you can use the Morningstar Sustainability Rating to evaluate the ESG performance and impact of different funds or ETFs. Some of the common ESG approaches include:

Negative screening: excluding companies or sectors that do not meet certain ESG criteria or standards, such as tobacco, weapons or fossil fuels.
Positive screening: pro-actively selecting companies or sectors that score high on ESG criteria or standards, such as renewable energy, health care or education.
Impact investing: investing in companies or projects that aim to generate positive social or environmental impacts alongside financial returns, such as clean water, affordable housing or microfinance.
Active shareholding: many funds and investment firms are engaging with companies directly on ESG issues through voting, dialogue or shareholder resolutions, in order to influence their behaviors and practices.
Monitor and review your ESG portfolio: The fourth step is to monitor and review your ESG portfolio regularly and adjust it as needed to reflect any changes in your preferences, goals, risk tolerance or market conditions. You can use various sources and tools to help you monitor and review your ESG portfolio, such as online dashboards, reports, or alerts.

What Questions Should I ask Clients About ESG?

To help clients determine if ESG investing aligns with their goals, ask the following questions:

What are your investment objectives and risk tolerance?
What are your personal values and beliefs that influence your investment preferences?
Which ESG issues are most important to you? Which of the E, S, and G do you prioritize most?
Are you willing to accept potential short-term underperformance for long-term ESG benefits?
Do you prefer a negative screening approach or a proactive investment in companies with strong ESG performance?

The History and Future of ESG Investing

The core concept of ESG investing has existed for centuries, dating back to religious codes banning investments in slave labor in the 1800s. Fast-forwarding to the 1960s and 1970s, divestments from defense companies in protest of the Vietnam War and from South Africa were first advocated to protest the country’s system of apartheid. These were among of the first examples of using social criteria to exert pressure on companies and governments to change their policies and practices.

The term ESG was officially coined in 2005, following a report by the United Nations titled “Who Cares Wins”, which argued that incorporating ESG factors into financial analysis and decision making would lead to more sustainable markets and better outcomes for societies. The report also launched the UN Principles for Responsible Investment (PRI), a voluntary framework for investors to integrate ESG factors into their investment processes.

Since then, ESG investing has grown exponentially in terms of both investor interest and assets under management. According to various sources, the amount of assets under management (AUM) in ESG investing has reached trillions of dollars in recent years. For example, PwC’s Asset and Wealth Management Revolution 2022 report predicts that ESG-related AUM is expected to reach $18.4 trillion in 2021 and grow at a compound annual growth rate (CAGR) of 12.9% to $33.9 trillion by 2026. And, according toBloomberg Intelligence, ESG-related AUM could surpass $41 trillion by the end of 2022, driven by strong inflows, favorable regulatory changes, and investor demand.

As we look to the future, ESG investing is expected to continue to gain momentum and play an increasingly prominent role in the global investment landscape. Several factors are likely to contribute to this sustained growth, such as heightened awareness of climate change and other environmental issues, increased demand for transparency and corporate accountability, and the growing influence of younger generations who prioritize sustainable practices. Technological advancements and improved access to ESG-related data will further enhance the ability of investors to assess companies' ESG performance more accurately. Consequently, we may see the development of more sophisticated ESG investment products and strategies, as well as an increasing integration of ESG factors into mainstream investment decision-making. As a result, financial advisors must stay well-informed on the latest ESG trends and developments to help their clients navigate this rapidly evolving investment landscape.

Is ESG investing a niche market?

No, ESG investing has grown significantly over the past decades, with ESG funds reaching $34 trillion by 2026, according to Price Waterhouse Cooper, making up more than one-fifth of total managed assets.

Is ESG investing just a fad?

No, ESG investing is here to stay and will likely become mainstream in the future. The drivers of ESG investing are not temporary or superficial, but rather reflect deep and lasting changes in society, markets and regulations. As the world faces unprecedented challenges such as climate change, social inequality and corporate governance scandals, ESG investing offers a way for investors to align their money with their values, support positive change in the world and achieve long-term financial success.

Do ESG investments provide inferior returns?

ESG investing does not necessarily mean compromising returns for values. Numerous studies have shown that there is no trade-off between ESG performance and financial performance. In fact, some studies have found that ESG investments tend to outperform conventional investments over the long term, as they tend to have lower volatility, higher quality and stronger resilience.

The Bottom Line

ESG investing, which focuses on environmental, social, and governance factors, is becoming a significant trend in the investment world, capturing the attention of many investors. As the trend grows, clients are increasingly seeking ESG information and services from their financial advisors. This article provides advice for financial advisors on effectively discussing ESG investing with their clients, clarifying what it is, assessing its suitability, and debunking common misconceptions. It also offers insights into developing personalized ESG investment strategies. Despite its growing popularity, it's important to note that ESG investing isn't for everyone, and it's not without its challenges, including potential greenwashing and lack of standard reporting metrics. The article underscores that ESG investing isn't just a passing trend; instead, it reflects deep societal, market, and regulatory changes. As such, financial advisors must keep themselves informed about the latest trends and developments in ESG investing to effectively guide their clients in this rapidly evolving investment landscape.