Time for advisers to brush up on ESG investing

Any financial adviser who has not been asked about socially responsible investing by a client likely will be in the near future, and he or she needs to be well-informed.

As reported in last week’s issue of InvestmentNews, investments based on environmental, social and corporate governance criteria are growing in importance, especially among millennials. Last week, for example, senior columnist Jeff Benjamin noted the launch of a socially responsible IRA aimed at this younger cohort by digital investment firm Aspiration.

Socially responsible investing principles are not new. In the 18th century, John Wesley, the founder of Methodism, told his church members that their business practices should avoid harming their neighbors and that they should avoid investing in industries that could injure workers, such as chemical production.

Until recently, most socially responsible investing focused on avoiding companies that produced harmful products, such as cigarettes or coal, or was used to pressure companies to halt activities in countries such as South Africa during the apartheid era. The pressure on companies to withdraw from South Africa is credited with helping end apartheid.

This approach was criticized by academics as reducing the possible diversification of portfolios, thus increasing the risk of those portfolios and violating a key insight of modern portfolio theory: The only free lunch in investing is through proper diversification.

While some socially conscious investors still avoid companies and industries on principle, the modern approach seeks to rank stocks and portfolios on the basis of their exposure not only to such industries but also to the long-term risks of climate change. It also considers corporate governance practices. The result is portfolios that minimize investors’ exposure to costs associated with global warming, poor corporate policies and other risks.

Investors now have more than 150 ESG-oriented mutual funds to choose from, and that means advisers have more homework to do to become familiar with each fund’s strategy, how it meets each client’s investment and social objectives, and how it might fit into the overall portfolio. Whatever their personal feelings about such funds are, advisers need to get cracking to ensure they can appropriately advise their clients.