03.21.18

Investment’s Feel-Good Future: A Look at Ethical Investing

by: Rich Blake

First there were initials, like "SRI" and "ESG," and they were good. Good enough, anyway.

For more than a century, the "Socially Responsible Investing" banner sufficiently covered ethically inclined allocators, mainly led by religious institutions eschewing enterprises linked to vices such as alcohol, tobacco and gambling.

In more recent decades, a sister category came to literally define the space, accounting for a trio of environmental, governance and social (ESG) factors in the screening companies.

Exchange Traded Funds (ETFs) tied to ESG began launching around 2005 though assets didn't exactly pour into them and performance could be described as mixed.

Over the past decade, the "feel-good" investment umbrella has, like the number of investors interested in scrutinizing corporate behavior, grown wider. “Impact,” “mission-based,” “sustainable” and “responsible” are all now terms to be found preceding investment strategies. All are aimed at a similar objective: finding high-quality companies that also can offer stakeholders a sound night's sleep.

In recent years, such options have been deemed suitable for defined contribution plans. Bloomberg LP's $2.5 billion 401(k) plan has emerged as a trendsetter by putting ESG alongside Target Date on its priorities list, according to Pensions & Investments. The media giant's ESG option, the Parnassus Core Equity Fund, focuses on socially conscious U.S. large-cap companies. Although this fund represents only one percent of total plan assets, it turns out, not surprisingly, to be a popular option among the firm's younger employees.

Lift Off

Last year, investors allocated more than $6 billion into SRI/ESG/sustainable and like-minded products, according to Morningstar. That total is more than triple the assets that flowed into such funds in 2015.

The Morgan Stanley Institute for Sustainable Investing reports that sustainable, responsible and impact investing rose 33 percent from 2014 to 2016 to $8.72 trillion. Pax World, which launched the first SRI mutual funds in the early 1970s, now manages $4.7 billion. Such growth is mostly, but not entirely, being led by millennials.

Three-fourths of active individual investors described themselves as interested in sustainable investing, according to a survey published last year by Morgan Stanley. Some 86 percent of millennials who took part in that survey said they were interested in sustainable investing. Among the money managers launching sustainable platforms geared toward advisors in recent years: Vanguard, BlackRock, Pimco, State Street, J.P. Morgan and Goldman Sachs.

Impax Asset Management's acquisition of Pax has resulted in a $13 billion sustainable manager with global distribution. John Hancock, meanwhile, has joined forces with a pair of sustainability players, Trillium Asset Management and Boston Common Asset Management. "These days there are more advisors than ever willing to customize portfolios to accommodate the growing interest in ESG investing," said veteran personal finance journalist John Waggoner of Investment News.

Barring a sudden, unexpected spike in cynicism, the industry can expect the “ethical” and “sustainable” categories to continue to rise to the fore. But where is all this leading? Will 401(k) plans eventually see ESG command more than just a relative sliver? Are assumptions about millennials just that?

In some respects, the future appears to be happening now.

'We Have the Technology'

When a former banker, Jay Lipman, founded Ethic in Silicon Valley a little more than a year ago, he encountered an RIA community still grappling with the concept of how to integrate a client's belief system into their investment portfolio alongside tax optimization and risk tolerance levels. "Sustainable strategies have been difficult to distribute with any scale because individual investors have so many different views of the world,” he said. “There is no one standard definition or set of rules."

The inherent challenge of building a scalable solution presented Lipman an opportunity. "We now have the technology to, in essence, take an x-ray of a client portfolio and then seamlessly reconfigure it — remove the toxic components — so that it meets a client's ethical standards while remaining in line with other purely financial objectives," Lipman said.

Ethic, starting late last year, began white-labelling systems for this kind of diagnostic, focused on independent RIAs. Using Ethic technology, advisors can build a clean version of any portfolio and have it align with the parameters set by the client and still meet overall return goals.

Product Proliferation

An increasing number of investment vehicles, particularly ETFs, are being created with specific themes and causes at their core. In 2014, BlackRock and State Street created, with the help of seed money from the United Nations, two low-carbon ETFs (CRBN and LOWC, respectively). Today, there are at least 18 "clean" ETFs.

Various research tools are also proliferating with new, unique areas of focus. Wilshire created an index to measure companies' support of the hiring of military veterans. Earlier this month, Institutional Shareholder Services, known for its proxy voting recommendations, launched an online tool, its Environmental and Social QualityScore, aimed at measuring the depth and extent of disclosure practices regarding ESG factors.

A Deeper Understanding

Longview Strategies' Evan Zall earlier this year wrote of a tension among advisors caught with feet in two camps, younger and older, and with different perspectives on putting ethics front and center in portfolios.

Serving two segments can be done, he stressed. "Integrating sustainable investing requires understanding a new set of products, having deeper conversations with clients about personal values and altering your own story about how you can deliver for the new investor."