Retirement Weekly: Don’t let perfect get in the way of good enough when it comes to ESG investing
Sometimes when starting down a new path, it can be hard to take that first step. In fact, if you’re like me, you want the entire road map before you are comfortable moving even incrementally forward for fear of making a bad move somewhere along the line.
I’ve spoken to many investors who feel this way about dipping their toe into responsible investing.
Their interests are piqued as assets continue to flow into the space at a record pace. Morningstar, which measures flows into the Responsible Investing space globally, reported global assets in 2020 reached $1.65 trillion, and noted that they saw record flows in every region they measure. And that pales in comparison to what has happened in 2021. As of the end of the third quarter, Morningstar reported that assets in these ESG funds and ETFs reached $3.9 trillion.
And while they like the idea of putting their money to work with companies that have good environmental, social and governance (ESG) practices, fear of not doing it just right prevents them from taking the first step.
My advice? Don’t let perfect get in the way of good enough.
Where to start
To most clients, responsible investing is about aligning individual values with investments. Naturally, those values will vary investor to investor.
Working with an adviser, you can dig into those values — whether it’s addressing climate change, closing the racial wealth gap by investing in BIPOC communities, or funding companies with good governance practices — and make targeted investments into companies that exhibit those same values or in funds that score companies based on those principles.
At my company, we created a number of ways to help clients take the first step. We help our clients define what responsible investing means to them and how they can get started.
Even though there are ready-made funds to choose from, investors are wise to ask tough questions about the make-up of those funds.
One question we often hear from clients is “How do I know that the fund I own is truly integrating ESG into its decision-making process?”
These questions began to come up even more in the middle of 2021, former chief investment officer of sustainable investing at BlackRock, Tariq Fancy, started to question the impact of ESG investing.
He wasn’t questioning the desires of investors but instead the commitment and application of investment managers. His articles accused firms of “greenwashing.” Greenwashing is the act of making a portfolio or actions seem like they are more beneficial on ESG factors than they really are.
Fancy argued that because profits are the primary focus of Wall Street firms, they will only do the bare minimum to increase flows and maximize profits. For this reason, he suggested, ESG may do more harm than good.
To his point, in the third quarter of 2021, Morningstar reported that 270 new sustainable funds launched globally. During that same time period, asset managers also repurposed 346 funds to claim sustainability. That means there were 578 new “sustainable” funds in the third quarter alone.
We at RBC Wealth Management do think that there has been an increase in greenwashing over the past few years because the Morningstar report shows a significant increase in new products, while funds on the select list have not increased at the same rate. However, the notion that all portfolios claiming ESG integration are greenwashing is overly pessimistic and simply not true.
Our firm spends a lot of time vetting ESG solutions in every market around the globe and we continue to add new solutions that we deem true to ESG. Earlier this year, our manager due diligence team launched their ESG “Spectrum” ratings that classify asset managers as ESG or not. This process has allowed us to segment managers we believe are genuinely considering ESG factors and then make those managers available to our clients.
Investors who work with wealth managers with these kinds of resources can more easily sift through the noise.
Making sense of competing priorities
Another question may be around the types of securities held within a portfolio.
Responsible Investing comes in many different flavors and applications. As a result, one investor may prioritize reducing fossil fuel emissions, and another may prioritize social equity. Of course, neither is right or wrong, but they may end up with different portfolios.
There are also times when a single investor values things that create friction in their ESG portfolio. Let’s say, for example, an investor values both reducing fossil fuel emissions and social equity. They may want to invest in renewable energy technologies that promise to move society away from fossil fuels. However, the technology that is required to create fossil fuel-free power is expensive and therefore less available and less feasible in socio-economically disadvantaged areas of the world. Those same renewable technologies also rely on mining of precious metals such as copper — a key component to manufacturing wind turbines and solar panels Batteries, used in electric vehicles, also require mining of cobalt and lithium, which many investors feel conflicted about.
Depending on the views of the investor, a Responsible Investing portfolio may require some give and take. Utilizing ESG integration is an excellent way to have a diversified portfolio that can look at the vital ESG factors for each company owned in the portfolio.
Only getting better
Investors interested in seeing their values reflected in their portfolio have an opportunity to do that with ESG investing.
Yes there are hurdles, such as avoiding greenwashing, ensuring the vehicles you are investing in truly represent your vision and getting a solid return on your investment. Investors need to monitor the actions of their asset managers to make sure their actions reflect the values they hope to integrate.
But also consider we are still in the early innings of the life cycle of ESG integration. Even with the considerable growth in assets lately, ESG assets are still small relative to the broader investible market.
The progress over the past few years is remarkable and more exciting changes in this space are on the horizon.
Just because ESG investing may not be perfect doesn’t mean it isn’t worth starting your journey toward more sustainable investments.
Kent McClanahan is head of Responsible Investing at RBC Wealth Management-U.S. RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.