The recipe for successfully advising on sustainable investments

In the past 12 months we’ve seen a rising tide of interest in sustainable investments – once considered niche, now many investors, and a growing cohort of financial advisers, acknowledge that funds and assets which take environmental, social, and governance (ESG) factors into account have become mainstream. Moreover, they are noticing that sustainable investments are performing in line with, or better than, regular investments. 

In fact, ESG has become a regular part of many advisers’ discussions, not only around their clients’ investments, but also about their everyday lives. At a recent virtual roundtable, 'The ABC of sustainable investing – making ESG work for your advice practice', held by BT, Dave Rae, an adviser with Federation Financial explained how an incidental discussion about a client’s recent purchase of a hybrid Toyota was a great segue into a broader conversation about his values, and how they could be expressed through his investment portfolio.

It’s worth noting investors are often leading the conversations with their advisers about ESG. The majority of Australians (86%) believe that it is important for their financial adviser to ask them about their interests and values in relation to their investments, according to recent research by the Responsible Investment Association of Australasia (RIAA), which also notes that more than three-quarters of Australians believe there is not enough independent information about ethical or responsible banking and superannuation funds available. This shows there’s plenty of scope for advisers to shift their discussion with clients in this direction. 

Healthy fund flows into investment products with an ESG or sustainability focus also mean now is the time for advisers to build knowledge of ESG, and the different ways investors can access investments in this category. For instance, by the end of the second quarter of 2020, Morningstar estimated retail assets invested in sustainable investments reached $19.9 billion, a 21% increase compared to 30 June, 2019.

Which is why it’s essential for advisers to develop their understanding and skills in this area. Here are three takeaways that can help you engage clients on this emerging and important topic. 

1. SUSTAINABLE INVESTING CAN BE PART OF YOUR GROWTH STRATEGY 

While Australians expect our super and other investments to be invested ethically, many have yet to develop a sound understanding of what ESG really is. That’s not surprising as there’s a lot of information to grasp, and investment jargon to wade through. 

The recent bushfires, floods and the COVID-19 pandemic mean it’s never been more important for advisers to engage clients on ESG. You might think this is a topic you’re just starting to explore. But this is actually an opportunity to bring clients along on this journey. Sustainable investing is developing rapidly, so it’s perfectly acceptable to let clients know you’re also on a quest to learn more about this area.

When I speak to advisers about sustainable investing, they’re often interested in how they can find investments that meet their clients’ needs, and what tools and resources they can use to inform their client conversations. 

I particularly recommend as a practical resource RIAA’s financial adviser guide which clearly explains the main concepts of ESG and sustainability investing as well as guidance on how to get involved. Taking advantage of all the free resources available to advisers is a great way to build confidence when talking to clients.

Never before have advisers had a wider range of options to build a portfolio of assets that take into account sustainability and ESG factors, with a growing range of choices across asset classes including fixed income such as green bonds and equities funds. 

According to RIAA, there are now 165 investment managers that apply responsible investment criteria to some or all their investment practices. These managers oversee approximately $1,900 billion in assets, which equates to 60% of all assets in Australia that are professionally managed. Investors can really build portfolios that effect change.

Advice practices that are developing their growth strategy in accordance with a longer time horizon may be well aware of an escalating trend – the great wealth transfer from baby boomers to younger generations, with the latter typically more engaged in sustainable practices and having greater interest in sustainable investing than their parents and grandparents. 

There are immense opportunities for advice practices that are well-prepared for the great wealth transfer – and conversely, risks for those that are not. Before wealth is transferred to the next generation, it is usually inherited by the surviving spouses. Research shows that advisers have a 44% retention rate when money moves between spouses; this drops dramatically to just 2% when it moves to the children. Understanding how these segments’ personal values inform their investment philosophy can help advisers retain them as clients.

2. SUSTAINABLE INVESTING JARGON CAN BE CONFUSING, SO HELP CLIENTS BY TRANSLATING IT INTO PLAIN ENGLISH 

A lot of the terms can seem confusing when you first get started in this area, which means the language can be even more perplexing for clients. It’s a good idea to start with the basics. Here are some accepted definitions of the main terms:

• Sustainable or responsible investing: An umbrella term that largely captures strategies that include non-financial ESG factors in the investment process to ensure investors are looking at the whole picture when making decisions; 
• Environmental, social and governance (ESG): The three main types of non-financial factors, such as environmental compliance, labour force relations or board skills and composition, that have, at times, been known to affect the risk and return of investments; 
• Impact investing: When investors use funds to create positive outcomes, for instance by investing in renewable energy or health care;
• Ethical investing: The idea of investing in a way that aligns with your personal values and beliefs, for instance by avoiding allocating money to gambling companies;
• Negative screening: Avoiding investing in certain companies, industries, or countries. It’s a tool investors can use to ensure they’re not investing in assets  that, for example, have high ESG risk or that don’t align with their personal values;
• Positive screening: Purposely investing in certain companies or industries that have a positive impact on society, or are better at addressing ESG risks and opportunities; and
• Asset stewardship: Investors engaging with company management teams and have some influence when it comes to encouraging them to adopt practices to improve their approach to ESG. Investors can also have some influence when voting on board appointments and company resolutions.

Many of these terms, like sustainable investing, responsible investing and ethical investing are used together or interchangeably. Again, RIAA has some good resources that can help cut through the jargon. The point is not to get too caught up in labels. It’s all about being mindful about how investors’ funds are allocated and ensuring they are aligned to your clients’ goals and interests.

For that reason, understanding why a client is interested in sustainable investment, or what they are interested in, might help you identify the right investments for them. 

What we’ve heard from advisers who have deep experience with sustainable investments is that clients display both active and latent demand for ESG investments.

Active demand is when clients specifically ask for sustainable investments or for their portfolios to exclude things like tobacco or gambling stocks or include renewable energy. 

You can also uncover latent demand – when clients want to pursue responsible outcomes with their funds but don’t actively ask for this – by asking the right questions. 
Sustainable investing can be a way to encourage your clients to engage with their investments, especially when you can identify specific, personal issues that resonate. Topical issues can be critical; for instance, when clients ask about the effect of climate change on their investments as a result of the bushfires. 

3. ESG OPTIONS ARE PERFORMING – AND CLIENTS SHOULDN’T MISS OUT ON THESE INVESTMENT OPPORTUNITIES

Some investors may be concerned about a trade-off between ESG investing and performance. But there’s ample evidence which indicates investments that take ESG factors into consideration can outperform over time, as well as during periods of market volatility. For instance, according to RIAA, sustainable companies performed better and responsible investment funds continued to outperform the general market during the worst of the market volatility in 2020. The difficult market conditions were a big test for responsible investments and we watched ESG fund performance closely. 

Of course, sustainable investment strategies are not a silver bullet, but the mounting evidence on the outperformance of sustainable investments is difficult to ignore, especially when considering how to act in the clients’ best interests. 

BEYOND ‘NICE TO HAVE’

As sustainability and ESG investing becomes more sophisticated, professional standards are also rising. There is also increasing regulatory interest in this area. The Australian Prudential Regulation Authority (APRA) has written to regulated entities encouraging them to consider the impact of climate change on their operations. Guy Debelle, deputy governor of the Reserve Bank of Australia has also spelt out how the central bank factors in climate change in monetary policy decisions. 

The Financial Adviser Standards and Ethics Authority’s (FASEA) code of ethics also means it’s important to talk to clients around this – so it’s not just a ‘nice to have’ part of an adviser’s responsibilities, it’s increasingly being codified into regulations as well.  

Jessie Pettigrew is senior manager, sustainability at BT.