Almost every conference or panel discussion about impact or sustainable investing starts with a discussion of terminology. Here is a terminology resource guide. Like the rest of financial services, our niche has an alphabet soup of terms- SRI, ESG, MRI, Sustainability, Green, Impact, etc. And while it's annoying that we have to start all of our conversations with a discussion about semantics, that discussion is incredibly important. As more investment companies offer SRI, ESG, and sustainable investment products and solutions, it's crucial for advisors to know the difference between the terminology and the products so they can appropriately serve their clients. The distinction between SRI and ESG, is especially important in the public equity and debt space.
The original innovators that brought this type of investing to financial services started from ethical, moral, values, and religious standpoints. This type of values-centered investing is called Socially Responsible Investing, or SRI. The first SRI funds excluded holdings from offensive industries such as tobacco, weapons, and gambling; and/ or they divested from companies benefiting from apartheid. Many of those funds and companies are still around today, and some have integrated ESG screening (see below) as well. SRI can (and -in my opinion- should) include shareholder engagement, a technique that uses dialogue with corporate management to encourage and pressure companies to improve their business practices for the benefit of people and planet.
Many of the recent entrants to sustainable and impact investing are traditional mutual fund and investment firms that are adopting ESG investing because considering non-financial information such as Environmental, Social, and Governance metrics gives a better picture of investment risks and opportunities. "Non-balance sheet risk" eventually makes it's way onto the balance sheet after a triggering event. The ESG approach evolved from SRI so the genesis of ESG is values-based; however the outcome is stronger risk identification, which over the long term can lead to better portfolio returns. (For an in-depth history of the SRI to ESG evolution, read this recent article by Georg Kell.)
If a company says they have an ESG investment product, that can mean a wide variety of things, including:
That they add ESG analysis after excluding "offensive" industries. (This is what most of those original SRI funds have evolved to do).
That they are investing in the companies that have the best ESG scores in each industry. This technique can lead to including "best of the worst" companies where for example, the weapons manufacturer with the best ESG scores is included in the investment portfolio.
That they review ESG data when making investment decisions, but don't necessarily base those decisions on the ESG data.
That they may day trade on ESG data changes and news.
That they may or may not engage in shareholder advocacy. They may even vote all of their proxies in line with management recommendations.
My Two Cents
The increasingly widespread adoption of ESG is, on whole, a good thing. Focusing corporations, investment firms, and investors on how companies can be better actors in their communities will usher in positive change. However, financial advisors must know what is inside the products labeled with Sustainable, Green, ESG, SRI or any other wrappers. And if clients want investments that align with their values, advisors need to be particularly careful to know the investment, engagement, and voting intentions of funds and/ or asset managers to match suitable products to the clients needs and wants, and then help set client expectations accordingly.
Have questions or want to learn more? Join my free virtual office hours. Or, are you ready to add an ESG solution that is aligned with both the philosophies and operational infrastructure of your firm? Let’s connect. Want more articles like this? Sign-up for the weekly newsletter.