How to Proactively Integrate RI into Your Practice

As the Responsible Investing (RI) market burgeons, Nalini Feuilloley, Director, Responsible Investment Team at BMO Global Asset Management, tells Advisors everything they need to know to practically – and successfully – incorporate RI into their practice, including how to avoid greenwashing, and important issues to have on your radar now.

Get Ahead of the Curve on Future Regulation

It’s no secret that the RI movement has grown exponentially in a short amount of time. Increasingly more mainstream investors have come to accept that RI is no longer a “niche-style” of investing – or a stylistic trend – but rather, a fundamental best practice.

Several factors have contributed to this evolution, including the $30 trillion intergenerational wealth transfer taking place currently¹: ageing investors are thinking about the next generation, while millennials – a large and important demographic for Advisors – are making more thoughtful decisions on how they want to contribute to their investment portfolios, as they look to solve the world’s sustainability challenges through the allocation of capital. And here’s the proof: according to a 2019 Morgan Stanley Institute survey of high-net-worth investors, 95% of millennials are interested in sustainable investing.²

In the institutional market, growth has also progressed enormously on the RI front, spurred by significant regulatory developments. Numerous environmental, social and governance (ESG) integration policies have been legislated globally, including the 2015 Pension Benefits regulations in Ontario. . And further top-down intervention can be expected, especially as regulators and central banks take heed of the potential financial implications of climate change, and encourage greater transparency from investors on how these are being managed..

Case in point: the Federal Government created the Expert Panel on Sustainable Finance to investigate ways the financial sector can help encourage and direct capital flows to support low-carbon Canadian initiatives, which included formal recommendations to promote sustainable investment as “business as usual” within the asset management community, and to provide investors with the opportunity and incentive to connect their savings to climate objectives.

Simply put, sooner rather than later, there will no longer be a choice as to whether we should be responsible investors – or Advisors. It’s a reality we ALL need to embrace within the investment management industry.

Sources: (1) PRI 2018 Reporting Framework responses, (2) “Global perspectives on sustainable investing – Global Investment study” Schroders, 2017 (3) Wealth X and NFP Wealth Transfer Report, 2016.

Expanding Your Understanding of Responsible Investing

Nevertheless, there’s still a misconception among Advisors (and their clients) that RI limits their universe, and equates to exclusionary, ethical investing – and therefore divestment. Yet that is only one approach of six under the RI umbrella. Alternatives include ESG integration, where investment managers are saying they analyse these factors from a risk perspective, and weighing them as legitimate business concerns as part of the due diligence process.

While it’s certainly valid to say “I don’t want to focus on thematic funds that address one issue in the RI sphere, such as climate change,” it would be detrimental for your business to disregard how ESG factors play a role in the management of client portfolios – especially for those invested over the longer-term. For example, Facebook showed many warning signs (from an ESG lens) prior to the massive data breach it experienced in 2018 that led to the biggest one-day drop in market value of any company in history. In retrospect, many could have avoided Facebook’s negative impact on their portfolio performance if they had incorporated governance factors into their decision-making processes.

Perhaps the biggest hurdle facing Advisors is the fear that RI approaches could conflict with fiduciary duty, or that these strategies can detract from performance. In fact, numerous studies have found evidence to support that taking ESG into account can actually help protect against volatility and downside risk.³

Data from the Responsible Investment Association (RIA) shows that nearly 75% of responsible managed funds domiciled in Canada outperformed their category averages over a one-year period, with similarly high (over 50%) proportions over longer three- and five-year periods.⁴ That’s why it’s vital for Advisors to take the time to understand what RI is – and what it’s not. We already know that Canadians want to learn how to invest responsibly: according to recent research, 79% of retail investors want to be proactively informed about RI options from their financial services provider, yet only 23% have ever been asked if these products interest them, suggesting a sizeable information gap.⁵

The Client Conversation: Becoming the Subject Matter Expert

So how do you incorporate RI into the client conversation?

As a first step, education is paramount in order to be effective. While you don’t need to be a specialist on every aspect of RI, you should be able to tell the story, including what it represents today, and what it means in terms of strategies, and the various approaches. Whether that means taking a course (see my list of educational resources below), or speaking to an expert, it’s incumbent on Advisors to grow your knowledge base as part of your professional development.

To start you down the path, click here for a tool to decode the intricate world of RI – helping you maintain an up-to-date toolkit so you can continuously add value, and differentiate your offering for clients.

I would then encourage Advisors to proactively broach the conversation and let clients know the different ways RI can manifest in their portfolios should they be interested. For example, you can recommend that you will diligence investment managers on their behalf to assess how ESG factors are integrated. Taking it one step further, pose the question: “do you have any specific values or beliefs you would like to see incorporated into the management of your portfolio?” If clients are passionate about certain causes (e.g. gender diversity, or climate change), then take them through their available options – from negative exclusion to thematic, or impact investing, the latter of which yields both a financial and social/environmental return.

Importantly, it’s about ensuring that clients aren’t stuck in the mindset that RI only represents ethical investing, or divestment, and widening their perspective to the many accessible – and robust – strategies.

Accountability: Delving Under the Hood

In terms of integrating RI into client portfolios, holding investment managers accountable is key, and the biggest component of this is delving under the hood, because “greenwashing” – a form of marketing spin that uses green values to deceptively persuade – is real and rampant as RI demand grows. The ESG integration approach is particularly relevant here since it has yet to be defined in exactly how it’s accomplished, and it transcends “RI/ESG” branded products. As a result, how ESG factors are taken into consideration is unique and proprietary to every manager; there is no standard benchmark. But that doesn’t mean it can’t be a valid and robust approach if there’s a material impact on buy, sell and hold decisions. For Advisors, that means asking pertinent questions like “what data sources are you using to screen for ESG?”; “do you have your own proprietary scoring method?”; “how does your approach affect your buy, sell and hold decisions?”

Some managers can answer basic questions readily because they have a stock response ripe and ready. If, however, you dig a little deeper, you’ll undoubtedly be able to discern the leaders from the laggards. Advisors should also question how managers use engagement and proxy votes to encourage ESG best practice with companies, which will help you inform your clients – and engender trust in the process.

Moving Forward with Climate Change

Looking ahead over the medium term, there’s no doubt that climate change will take the focus of the ESG landscape. As such, Advisors should educate themselves on the issue, and try to assess how much climate risk has been priced into their clients’ portfolios. In the run up to the critical COP26 climate meeting later this year, we can anticipate further government intervention, and while this is somewhat removed from the end client, we expect to see disruption in the financial sector if more top-down climate regulation is introduced. Therefore, prioritizing climate change as a central piece in holding investment managers accountable to these environmental factors will help soften the impending blow in the next three to five years.

Crucially, for Advisors, it’s a matter of not disregarding the RI movement and taking it for granted, because the alternative is to fall behind – particularly as client demand escalates. Realize that it’s not simply about branded funds, although these will be the right option for some: it’s about scrutinizing ALL investment strategies through an RI lens, and proving that ESG integration is a demonstrable part of every manager’s skillset and understanding. Ultimately, it’s an opportunity for true partnership – helping your clients fulfill their desire to make a difference, while maintaining healthy returns.

¹ Accenture, “The ‘Greater’ Wealth Transfer – Capitalizing on the Intergenerational Shift in Wealth,” 2012.

² Morgan Stanley Institute for Sustainable Investing, “Sustainable Signals – The Individual Investor Perspective,” 2019.

³ BMO Global Asset Management, “Performance with Principles”, 2017; University of Oxford and Arabesque Partners, “From the Stockholder to the Stakeholder,” 2015; Bank of America Merrill Lynch, “ESG Part II: A Deeper Dive,” 2017; Morgan Stanley Institute for Sustainable Investing, “Sustainable Reality,” 2015.

⁴ RIA Canada Q2 Funds Highlights, July 2019.

⁵ 2019 RIA Investor Opinion Survey.