In the U.S. alone, according to some figures, nearly $9 trillion of investment assets are managed to align with socially responsible mandates, which amounts to $1 out of every $5 managed professionally.
Despite this prevalence, there are many myths and misconceptions held by financial advisors that cloud their understanding of socially responsible investing, especially about client interest and the strength of available strategies. Financial advisors should consider socially responsible investing as an opportunity for business growth as integrating these offerings may be a critical component to remaining competitive in the industry.
Myth #1: Investors aren’t interested in socially responsible investing
While 63% of financial advisors report having little or no interest in responsible investing, the same simply cannot be said of investors. According to research conducted by the Morgan Stanley Institute for Sustainable Investing, 71% of investors are interested in responsible investments, with levels of engagement surging even higher among certain demographics. For example, 93% of millennials and 76% of women agree social and environmental impact are important factors to consider while making investment decisions, giving advisors the opportunity to foster new relationships with key client demographics. This “next generation” of investors are estimated to soon outpace baby boomers in terms of household wealth and stand to inherit $30 trillion in the coming decades.
Broaching the topic of socially responsible investing with clients and potential clients alike lets advisors convey their commitment to helping investors achieve their unique financial goals. Beyond providing advisors a way to access new demographics, socially responsible investing also offers the opportunity to increase wallet share with existing clients seeking to align their portfolios with their values.
Myth #2: Socially responsible investing means poor performance
Socially responsible investing began decades ago by simply eliminating companies that investors wished to avoid. However, an evolution has taken place since that time, aided in large part by the growth of Big Data. Many SRI strategies today seamlessly integrate Environmental, Social, and Governance data into their portfolio construction process. The objective is to create portfolios that promote positive societal change and have the potential to outperform peers and benchmarks on a risk-adjusted return basis.
This goal isn’t just a pipe dream; an ever-growing body of research suggests a strong association between responsible business management and positive financial performance. For example, CFA Institute reviewed a 2016 study in the Journal of Investing and found evidence that excluding companies that rank poorly in terms of ESG factors from a given investment universe has a positive effect on portfolio construction and returns. Additionally, Morningstar research found that the distribution of star ratings among sustainable investing funds skews in a positive direction, suggesting better risk-adjusted performance than their peers.
Integrating ESG data into a portfolio management process also has the potential to enhance risk management. Businesses with poor values-based governance may expose themselves to risk through negative publicity, regulatory sanctions, or other costly workforce issues. Take, for example, the recent Equifax cybersecurity scandal. MSCI’s ESG Ratings identified poor data security in August 2016 and downgraded Equifax’s rating, long before Equifax revealed the cyberattack in September 2017.
Myth #3: There’s only one way to implement socially responsible investing
Socially responsible investing can have a different meaning for each investor. While that allows for an endless variety of investment options, it can also be confusing and overwhelming for clients and advisors alike. For instance, some clients may be interested in avoiding “sin stocks,” such as investments pertaining to alcohol, tobacco, and firearms. However, others may be focused on investing in and engaging with companies working toward social missions like gender equality or environmental sustainability.
In addition, investment approaches may resonate more or less with different investors depending on their values and financial goals. Financial advisors can consider a passive approach, designed to track to an index, or an active approach, in which managers exclude or double down on certain companies.
Advisors who either understand the complexities and nuances of socially responsible investing or work with firms that specialize in SRI will be best positioned to meet their clients’ needs.
The bottom line is that socially responsible investing is not just another investment fad; it’s a dynamic strategy that financial advisors can leverage to grow their businesses and convey their unique value to clients in today’s competitive climate. While common misconceptions like these continue to exist, integrating SRI solutions into a practice provides an opportunity for financial advisors to deliver competitive portfolios while creating long-lasting client relationships.