Originally published: January 30, 2019
While socially responsible investing has been around for over 30 years, it is now just becoming accepted by the mainstream financial industry – an industry that relies on constant technological change. Today’s investors are much more sophisticated, have incredible tools at their fingertips, readily accessible research and a reborn passion to make a difference with their life and investment choices.
However, with an increased sensitivity to long-term financial planning needs, many are hesitant or just not willing to give up on returns or take on more perceived risk even though they want to “do-good”. The challenge then is to design socially responsible portfolios, also referred to as “sustainable,” “impact,” or “Environmental, Social and Governance (ESG) portfolios that are designed to modulate risk, while maximizing returns.
It’s not enough to assume the investment process is successful solely because an investor has found socially responsible companies to invest in. “Finding” is not the hard part; portfolio construction and maintenance is a horse of another color – and a complex one at that. In fact, managing an ESG portfolio requires the same discipline and skill as any other portfolio. The gender of the selection strategy simply does not mean that other portfolio management techniques that have evolved over time should be abandoned or minimized.
Constructing an ESG portfolio has been greatly aided by independent, unbiased and transparent corporate evaluators. MSCI, one of the leading ESG rating firms, claims that they rate over 6,500 companies that meet their acceptable ESG standards. Morningstar provides their Morningstar Sustainability Rating for thousands of mutual funds and ETF’s available to US investors.
The good news is that there are lots of ESG investment choices including household names like Amazon, American Express and McDonalds as well as many of today’s newer tech firms. There are, of course, some exceptions depending on where one stands on medical research protocols.
By the way, ESG investing is not just for millennials. It applies to all generations, even grandparents – the baby boomer generation – that has found a renewed voice for social causes that characterized their earlier years in the 60’s and 70’s. Now many see an opportunity to use their wealth to promote their social consciousness. Most recently the sight of a grandparent accompanying their grandchild to a rally protesting social injustice struck me as particularly poignant and perhaps a bond unparalleled in history.
There is no reason why ESG portfolios should not be more sophisticated, utilizing the latest techniques in portfolio construction and risk management. That means considering more diverse asset classes than are typically seen in current ESG investments and portfolios including small and mid-cap equities, and fixed income categories like high grade and international bonds. The more asset class categories, the more reliable risk models can be. Failure to optimize portfolio construction, including ESG portfolios, may result in investors experiencing a loss of value particularly thru the natural market cycles that various asset classes employ therefore lowering returns in the long run. Without the addition of an expanded ESG portfolio ones returns can be dangerously risky and volatile.
Financial advisors involved in the ESG arena need to better educate their clients on the benefits of an ESG asset class. Clients should also ask their advisors how a potential ESG portfolio will fit into an overall asset allocation plan or “strategic model portfolio.” This open dialogue will only strengthen the relationship between advisor and investor, ensuring that all parties are on the same page regarding the client’s goals and objectives.
Whether or not ESG represents an alternative asset class or merely a subset of existing asset classes is a philosophical question. It very well could mean that because of today’s socially responsible trends these types of investments may represent a better opportunity to reach ones goals, especially on the premise that “green” is good.
If, in fact, ESG investments can be grouped together as a unique category of investments, how or where would they fit in an overall investment plan needs to be thoroughly determined. Does ESG investing replace a category or is it carved-out from other investment categories? Where would this new asset class fit in the modern portfolio structure? These are just some of the questions that investment professionals and investors are pondering.
Our firm recently made the decision to develop a variety of ESG oriented investment solutions for our clients to primarily address their growing sensitivity to have more control of how their assets are deployed. We continue to see the trend of “vote my dollar” becoming stronger as ESG investing becomes more mainstream and an accepted and important asset class for investors of all sizes.
This article is created and authored by Charles Hamowy, CEO of Seasons of Advice® Wealth Management, LLC and is published and provided for informational and entertainment purposes only. The information in the article constitutes Mr. Hamowy’s own opinions and do not necessarily reflect those of Seasons of Advice® Wealth Management or Moneyinc.com
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