How to Discuss SRI, ESG and Impact Investing With Your Clients – ThinkAdvisor

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In contrast, more than 20% of companies in the S&P 500 are exposed to animal testing, so a blanket avoidance of animal testing would have a consequential impact on the investment opportunity set.

ESG Considerations

SRI and ESG integration strategies may differ in material ways. SRI strategies typically avoid certain industries and companies regardless of price; ESG integration strategies may find a price at which a company would be an appealing investment despite ESG risks.

For example, a fossil-fuel-free strategy may explicitly exclude Exxon or Chevron stock, but an ESG integration strategy might own one or both stocks if the price was attractive enough to offset ESG risk considerations. In addition, some ESG investors may distinguish between traditional energy companies that can successfully contribute positively to a net-zero world and those less able or willing to adapt.

ESG ratings provided by MSCI, Morningstar and others are often compared unfavorably with credit ratings, as ESG ratings exhibit a far lower correlation than credit ratings. The comparison between ESG and credit ratings may not be an appropriate comparison.

Just as there isn’t universal agreement about the valuation of a company, there may not be universal agreement about the ESG merits of a company. A company that gets high marks from one rating firm may get dramatically different ratings from another, for perfectly legitimate reasons.

Few companies are universally “good” or universally “bad.” Tesla is a favorite of many environmentally focused investors for its leadership in the transition to a lower-carbon world. Social and governance-focused investors may be less enthusiastic about Tesla given shortcomings in the firm’s governance structure, Elon Musk’s battles with regulators, and labor relations that have not always prioritized worker safety.

The ESG merits of leading technology companies is another area of potential disagreement among ESG investors given different but defensible assessments about issues such as privacy, supply chains, labor conditions and antitrust.

Impact Investment

ESG investors focus on how companies go about doing what they do; impact investors focus more on what they do. Among the problems addressed by impact investors are poverty, hunger, education, inequality, clean water and sanitation, clean energy and climate action. The United Nations Sustainable Development Goals and targets reveal many areas of potential impact.

The highest impact opportunities may be with companies trying to solve some critical problem that would otherwise be left unaddressed. Companies with a material focus on one or more of these targets would meet the impact definition; impact-focused investors assess whether the company’s core business is authentically creating impact.

Companies that make furniture or sell software in a sustainable way may meet the aspirations of SRI or ESG investors but often fall short of impact targeted by impact-focused investors.

Conclusion

Advisors play a vital role in providing education, helping clients decide what approach or combination of approaches best aligns with the client’s preferences. Some clients may prefer the values-alignment provided by an SRI approach; ESG or impact-oriented strategies may resonate more with other clients.

Another key role for the advisor is to look beyond marketing hype to assess the authenticity of an SRI, ESG or impact offering. In many cases, particularly with the proliferation of thematic products, the product offering may have more style than substance. Ultimately, a well-informed client is more likely to remain a satisfied client.

Daniel S. Kern is chief investment officer of TFC Financial Management, an independent, fee-only financial advisory firm based in Boston. Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds. Daniel is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. He also sits on the board of trustees for the Green Century Funds.