ESG Investing Slowly Going Mainstream

Nearly nine in 10 asset managers polled for a recent Cerulli Associates report view increasing attention to environmental, social, and governance (ESG) strategies as a lasting trend.

Although many investment managers see the growth of ESG as a permanent shift that will influence the long-term investment strategies they implement for clients, most managers only consider it to be somewhat important for managers to offer ESG capabilities today. Cerulli notes this is a significant development, however, as most asset managers have historically thought of socially responsible investing as a niche area that appealed only to religious groups and certain other mission-based, nonprofit organizations.

Today, managers are observing increased demand for ESG from all types of clients and prospects, Cerulli says, especially in the institutional and retirement planning channels (see “Running the Fund: Looking Ahead Responsibly”). As Cerulli explains, institutional sales teams increasingly report that large asset holders, such as defined contribution and defined benefit retirement plan sponsors, are inquiring about the potential benefits and drawbacks of ESG strategies.

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Cerulli says request-for-proposal (RFP) teams at investment management firms are reporting a significant rise in the number of RFPs with embedded ESG-related questions. The questions encompass several areas, from the fiduciary implications of implementing an ESG portfolio to the potential environmental or political risks that can be addressed by ESG screening strategies.

As explained by Cerulli, ESG investing strategies can be enacted in a variety of ways. One common approach is to apply “ESG screens” to a portfolio, through which the manager cuts out investments in securities that are sensitive to things like water shortages, food scarcity, or social unrest/injustice. Cerulli researchers suggest there is increasing acceptance among institutional investors and asset managers that ESG factors can have a material impact on the security-issuing company’s financial well-being, as well as overall capital market performance (see “Running the Fund: Win-Win”).

Some industry professionals point to the long-term nature of the potential impact of ESG factors on a given company or security as dilutive of ESG’s importance in the portfolio-building process, Cerulli explains. This is an especially important matter in the retirement planning context, wherein plan sponsors and other named fiduciaries must make all investing decisions in the best financial interest of their participants. The Department of Labor (DOL) has even issued guidance reminding plan sponsors that ESG factors, when they are not clearly material to the performance of a given security, can at most serve as a tie-breaker between economically indistinguishable investment options.

But as Cerulli explains, more retirement plan sponsors are linking the long-term nature of their participants’ investing interests with the growing importance and materiality of ESG factors. A given retirement plans’ termination date often extends far into the future, if one is set at all, so it becomes challenging to assess whether long-term problems like climate change or water scarcity should factor into investing decisions made in the short-term.

Whatever the case, many asset managers have witnessed a moderate (65%) or significant (13%) increase in demand among clients and prospects for a written commitment to The United Nations-supported Principles for Responsible Investment (UNPRI) Initiative. As Cerulli explains, UNPRI Initiative signatories pledge to implement a list of best practices for responsible investing.

Cerulli says some asset managers are even employing ESG capabilities, and their UNPRI signatory status, as a differentiator when presenting their approach to managing risk, generating returns, or both.

Looking to the portfolio building process, many managers anticipate that the greatest growth potential for ESG among asset classes will be in U.S. equity (78%) and international equity (74%). Several factors shape this view of asset class potential, Cerulli says. For instance, U.S. equity and international equity are among the most commoditized asset classes—so ESG can be a valuable differentiating factor.

Cerulli observes that private equity and other alternative investments, such as real estate, operate with greater flexibility and are bound by fewer liquidity constraints than highly regulated vehicles. This allows alternatives managers to invest directly in unlisted companies to facilitate impact investing or other ESG factors, such as shareholder advocacy.

Even with new attention, Cerulli is quick to add that only about 26% of managers say they receive frequent questions from institutional clients about ESG issues. Another 32% say they have received a small number of queries during recent sales or client relationship management efforts, while 42% have seen little or no client attention being paid directly to ESG.

Perhaps for this reason, only about 17% of asset managers say ESG is already very important. Another 78% say it is somewhat important, leaving just 4% neutral on the importance of ESG.

More information about how to obtain the full Cerulli analysis of ESG investing, contained in the August 2014 issue of “The Cerulli Edge – U.S. Monthly Product Trends,” is available here.

Partnership Hoists Importance of Financial Wellness

Retirement readiness can be strengthened by financial wellness programs, say Compass Financial Partners and Financial Finesse, which recently agreed to partner.

During employee meetings, no one raises their hand when you ask who wants to depend on Social Security for retirement, says Kathleen Kelly, managing partner of Compass Financial Partners. “Everyone understands that they are responsible for managing finances to support their own retirement,” she tells PLANADVISER. But as plan advisers often observe, retirement plan participants face a range of financial challenges.

Kelly calls them roadblocks, and says Compass wanted to help plan participants address these other issues, and decided to take its relationship with Financial Finesse a step further. (See “Compass Integrates Financial Wellness Program.”) “Liz Davidson [chief executive of Financial Finesse] is a pioneer in the industry,” Kelly says, “an incredibly successful woman who really understands that implementing a financial wellness program in a company has good return on investment for the employers.”

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Until now, Financial Finesse has not partnered with any advisers, but Davidson says that Compass has a number of differentiating characteristics. “They’re in a strong position as a large independent adviser, growing rapidly,” Davidson tells PLANADVISER. “They have the luxury of thinking long term, asking where the market is going, especially as it relates to participants and retirement readiness.”

Compass has a mission-based perspective, Davidson feels, looking at how to solve the problem of retirement readiness for plan participants. “The retirement plan advisers who are most successful at helping people retire on time with sufficient assets are the ones who are going to grow, and their growth will be at the expense of those working with quick and ineffective solutions,” Davidson says.

Davidson points out that during the RFP (request for proposal) process, advisers often give just cursory attention to financial wellness. They might depend on older approaches, she says, such as lunch-and-learns. Or they won’t provide any details at all about what they will offer clients in terms of education and communication.

The traditional focus of the retirement plan industry has been how to educate participants, Davidson says. “It’s all about the enrollment meeting, but not looking at participants’ other financial issues,” she says. When people don’t take positive action or engage more with the plan, employers should not be surprised. The problem is often not with the plan, but with people’s bigger financial picture. 

“Most people love the plan and understand it’s favorable,” Davidson says. They need help in knowing how to afford it in the face of debt, a mortgage, college tuition, and daily bills—in short, in understanding how to look at finances more holistically.

The partnership will bring more infrastructure, content and subject matter capabilities to Compass, Davidson says. the partnership will also involve event management and marketing, online registration, e-blasts, posters, postcards and various other financial wellness materials. “They can cover more topics, have a more holistic approach and have streamlined implementation,” Davidson says. An event management system can even track which employees have gone through an online assessment and show how well the combined financial wellness program is working.

“Participants need to see that the plan is about them,” Davidson says. “And that is the way you change behavior, by making it about the person, not the plan, or the benefit, or the technical aspects.”

Kelly says the partnership will help the advisory firm’s plan sponsor clients improve retirement readiness for their workforces. “We look at the partnership as an additional building block to deliver best-in-class financial wellness to a broader swath of participants,” Kelly says.

Compass also wanted to dedicate more resources to financial wellness, because of their need to provide independent due diligence and best practices in fiduciary governance to plan fiduciaries. Financial wellness for plan participants is part of their strategy to improve overall plan success, Kelly says.

Kelly says financial wellness programs lift participant engagement. About 75% of plan participants who had a sit-down session with a financial planner changed something about their participation, ranging from an increase in plan contributions to a change in asset allocation or other positive action.

“If the building blocks aren’t in place for participants to make decisions, because they’re concerned about debt or have other issues, that is going to prevent them from maximizing the full benefit,” Kelly says. “We believe helping employees become more empowered in their decision-making and in their overall financial picture what will help them to retire with dignity.”

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