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Advisors Find Opportunities with SRI Funds

By Murray Coleman November 7, 2016

As passive ETFs and index mutual funds keep gaining steam, one bright spot for advisors partial to actively managed funds is socially responsible investing.

In the past five years, SRI fund assets have jumped 76% to $201.3 billion, according to Morningstar data through September. Active funds, both mutual and ETFs, represented 83% of that total.

Money flows into U.S. mutual funds and ETFs show an even starker picture for advisors who favor hiring experienced managers to help guide client portfolios, points out Tom Manning, chief executive at F.L.Putnam Investment Management in Wellesley, Mass.

“Sustainable investing appears to be the only area of active management that’s still attracting positive flows and growing – it’s certainly taking market share away from other types of active investing opportunities,” says Manning, whose indie RIA manages $1.5 billion.

Indeed, Morningstar estimates more than $1 billion has poured into SRI stock funds in the initial eight months of 2016. By contrast, the Chicago-based investment researcher says investors pulled nearly $161 billion from all U.S. stock funds in that period.

“Offering clients an investment process that includes active ESG options isn’t only a way to differentiate yourself, but it’s also a way to build trust and enhance long-term relationships with clients,” says Molly Betournay, head of impact investing at Pathstone Federal Street in Fort Lee, N.J., which manages about $7.5 billion.

Still, many advisors seem to be avoiding a fast-growing SRI market, which includes subsets such as impact investing, ESG and generic sustainable investment strategies. By some recent industry surveys, anywhere from 60% to 70% of U.S. FAs haven’t yet adopted values-based investing into their portfolio construction processes.

“Passive funds have their place but we warn clients against ignoring active management’s positive long-term attributes,” says advisor Sacha Millstone of Raymond James & Associates in Boulder, Colo.

She’s been managing portfolios with a socially responsible theme since 1986. Her team, which manages about $450 million, takes a neutral stance between active and passive usage.

Sacha Millstone

But given a rather short history for most ESG-minded index mutual funds and ETFs, Millstone finds that allocating a majority of her clients’ assets to passive fare remains a less-than-ideal long-term strategy.

Also complicating matters, she says, is less of a selection. Indeed, by Morningstar’s count, active funds with SRI themes outnumber passively managed rivals by a more than 3-1 margin.

For the time being, Millstone says she’s content with “sprinkling” passive SRI funds into the mix as a way to provide broad domestic stock exposure and to help dampen investment costs for clients. At the same time, her practice’s core ESG holdings are invested through various active fund managers.

Since 2011, Millstone notes, domestic market volatility has been fairly low.

“So clients want to know these days why they need to pay up for active management,” she says.

Millstone uses various performance charts to show clients that while a passive approach might do well in strongly upward moving markets, funds with veteran managers at the helm can steer past much of the carnage in market meltdowns.

“We like to remind people that you never know when rough spots are going to show up,” she says. “So instead of trying to time markets, we reinforce the need to tap into the expertise of experienced managers with strong track records in SRI markets.”

At F.L. Putnam Investment Management, advisor Manning also blends passive ETFs with active management in building sustainable portfolios. But he says that the “vast majority” of such SRI mandates take an active bent, either through mutual funds or his staff’s own individual stock selection process.

“We find that simply following sustainable indexes is often too limited of an approach – it’s hard to sift through an index to match an individual’s core value system,” Manning says. “Indexes just don’t always provide enough differentiation.”

Pathstone Federal Street’s Betournay also finds that passive strategies in ESG investing rely on somewhat generic data compiled by outside ratings firms. For example, corporate governance figures used to rank ESG factors by benchmarkers might consider raw numbers such as how many independent directors are employed and how many minorities are on a company’s board.

But some savvy active managers, Betournay points out, look past such “top-line” data crunching. They might dig into how top officials’ bonuses and compensation are tied to greenhouse emission targets. Some ESG managers will scrutinize a company’s gaps between high wage earners and lower-compensated employees.

Other issues that clients like managers to investigate, Betournay says, include a range of workplace gender issues and proxy voting patterns. She even finds that some families are interested in finding out about companies with histories of paying relatively low taxes in relation to profits.

“We believe that a deeper dive into ESG factors is a good way to find pockets of opportunities that aren’t always the same as index-tracking funds might find,” Betournay says.