On April 22, the world will celebrate the 52nd annual Earth Day, a global event focused on drawing attention to environmental protection. The theme for 2022 is “invest in our earth”—and as a successful financial professional, you are well positioned to help clients and prospects take action on this theme.
Indeed, generations of Americans have awakened to (and embraced) the power their spending choices may wield in terms of making the changes for the better that they want to see happen. Likewise, more and more investors are incorporating their values in their portfolio allocation decisions.
For these reasons—as well as for its potential effectiveness as an investment strategy—environmental, social and governance (ESG) investing has gone from a highly specialized topic with limited mainstream relevance to a well-known and widely accepted concept. In fact, you can hardly escape the subject in today's financial media and markets.
As a successful financial professional are you taking full advantage of the burgeoning trend toward responsible investment best practices such as ESG in your business? Similar to the way new technology is reshaping the way you work with clients, new ideas like ESG are shifting the economic paradigm in fundamental ways not to be underestimated nor to be overlooked.
Perhaps this Earth Day is an ideal time to have a goals-based ESG discussion with your clients.
A timely opportunity to discuss ESG investing
Recent leadership changes in the U.S. government, ongoing demands for improved social justice, and a global push for environmental reform are creating important responsible investment themes that may spark investment conversations during 2022. Key ideas to explore with clients may include:
- Environmental policy changes to confront climate change.
- Corporate accountability in regards to social factors (the “S” in ESG) including systemic racism, diversity and inclusion efforts, and political donations.
- Investment growth, especially in fixed income products such as green, social and sustainability bonds which differ from traditional bonds in their use of proceeds.
- Sustainability and biodiversity (aka the variety of living species on Earth).
- A climate of opportunity: what the rejoining of the Paris Agreement could mean for responsible investing.
Business case for ESG
Over the last decade there's been a steady increase in capital directed toward ESG strategies—the growing subset of responsible investing that incorporates long-term sustainability issues into its decision-making criteria. And interest in ESG has become even more pronounced in recent years.
Assets in the ESG investing category now total $17.1 trillion, according to a 2020 biennial report from the Forum for Sustainable and Responsible Investment (US SIF). That's up from $12 trillion in 2018, or a 42 percent increase in two years.
Growing investor interest in ESG may be due, in part, to the pandemic, natural disasters and renewed focus on racial equality that have dominated the news cycle for several years now.
(For related information on timely financial industry topics, please see the following previously published Perspectives articles: how to help clients prepare for a financial emergency,1 when disaster strikes, know how you can help2 and three ways to diversify your business.3)
Factors like climate change, for instance, are a very real risk. So companies that recognize that risk, and develop a strategy for it, will be better positioned than those that don't. For example, our parent company, Royal Bank of Canada, recently published its Climate Blueprint
Incorporating environmental, social and/or governance criteria in business goals creates a win-win situation. By enhancing financial accounting requirements with non-financial performance metrics, better outcomes for the planet and society may be produced while also generating returns for investors.
Gains for the planet and portfolios
By focusing on sustainability factors, ESG investing offers the opportunity for investors to make a positive impact. The question, though, is whether they need to sacrifice gains in the process.
According to research by RBC Capital Markets, ESG principles don't require investors to give up potential returns, and in fact may add to them. Think of it as a built-in quality screen for equities. If you're selecting only those companies that have thought seriously about future risks and prepared for them, it would make sense that those companies might outperform in the long term, compared with others that haven't thought beyond the next quarter.
When discussing the merits of ESG investing, one of the first responses clients may have is something along the lines of: “Sure, it sounds like a great idea, but do I have to give up anything in order to do it?” To help further educate clients, you might say that in normal markets, ESG portfolios can do well, and in down markets, you have the added benefit of being invested in companies that have prepared for future risks.
Obviously, past performance doesn't guarantee future results but there is little reason to believe clients have to sacrifice to integrate ESG into their portfolios. In fact, ESG outperformance has spiked, even as the COVID-19 pandemic hit according to the RBC Capital Markets research. That may be because these companies tend to be better run, use fewer resources and are exposed to less risk.
At the height of the pandemic, Chicago-based fund research firm Morningstar looked at first-quarter 2020 performance—a rocky period for equities—and found seven out of 10 sustainable funds finished in the top half of their categories. And 24 out of 26 ESG index funds bested their conventional counterparts.
Three different approaches to explore with clients
Once investors are interested in taking a values-based approach to asset allocation, they may want your help building a portfolio that supports their personal beliefs in addition to helping them achieve their financial goals. Given the different niches and terminology related to responsible investing, you and your clients have a number of choices.
There's socially responsible investing (SRI), which typically means screening portfolio options to eliminate securities from issuers that clients want to withdraw support from. For example, if a client is morally opposed to tobacco, you can avoid stocks for tobacco companies or mutual funds that invest in companies that produce tobacco products.
SRI is one of the simplest approaches to responsible investing and it dates back literally centuries to Quakers who used it during colonial times to build wealth in a manner consistent with their religious precepts. It may be even older than that.
One challenge with SRI, however, is knowing where to draw the line regarding avoidance. Using the tobacco example, would your client want to go as far as eliminating securities for retailers who sell tobacco products? How about funds that include retailers who sell tobacco products?
Or consider impact investing, where there is a clearly stated altruistic benefit that is the primary purpose of the investment and producing a financial benefit for the investor is secondary. This approach may allow your client to draw a direct line to the positive changes their money has brought about. It may be easier to do with fixed-income products, such as purchasing bonds to fund water projects in thirsty parts of the developing world.
Then there's ESG, which usually refers to a positive focus on best-in-class performers. Instead of eliminating whole sectors, you're looking for specific securities issuers that are doing better than their peers on environmental, social and governance issues. Examples may include looking for criteria related to carbon footprint (environmental), labor relations (social) or workforce diversity (governance).
And investors can drill deeper into these guideposts and ask questions like: does a company take environmental issues seriously, with a thoughtful approach to water usage, greenhouse gas emissions and waste management? What about social issues like workplace health and safety, community and government relations, corporate philanthropy and workforce diversity? Is it transparent in its governance structure, with best accounting practices, reasonable executive pay, an accountable board of directors and regulatory compliance?
An ESG form of screening helps solve a major problem for investors by making values-based investing quantifiable and manageable. However the growing popularity of the ESG strategy also introduces a challenge.
Sometimes referred to as “green washing”—or advertising some form of environmental benefit—how do investors determine if securities issuers are truly operating by ESG principals or if they are promoting environmentalism because it's the trendy, and sometimes profitable, thing to do?
Beyond the fact that many corporations are claiming to be doing well by doing good, asset managers are similarly claiming that they consider ESG factors when creating their portfolios. So it may be difficult not to be skeptical about the proliferation of ESG investment opportunities.
How to construct ESG portfolios with confidence
Because of this explosion of interest in ESG, the global manager research (GMR) team of our sister company, RBC Wealth Management, has created a framework for segmenting managers who are authentic in their ESG integration versus those who are not. GMR evaluates investment managers on their firm commitment, investment professionals, and investment process. Using this criteria, they have created a system to help segment authentic ESG managers.
The RBC ESG Select Portfolio (delivered through the RBC Wealth Management Portfolio Advisory Group) offers a solution to financial professionals who use the independent broker-dealer services offered by RBC Clearing & Custody. Plans are underway to make this solution available to financial professionals who use our services for the registered investment advisor business model.
The RBC ESG Select Portfolio provides investors with globally diversified multi-asset-class strategies that combine a strategic and active approach with a view toward integrating ESG into each investment. Overlaid with disciplined risk management consistent with each strategy’s investment objective, this suite should appeal to financial professionals and investors who seek a one-stop solution to gain exposure to a global asset allocation strategy with ESG as a primary consideration.
The suite is designed to give you a way to easily implement an active, ESG-integrated, global asset allocation strategy via a combination of solutions, including exchange-traded funds (ETFs) and mutual funds. These portfolios combine a long-term strategic focus with the flexibility to shift the asset mix based on the relative merits and risk-reward balance of equities, bonds, sectors, and regions.
Through active management, the portfolio suite also seeks to earn a total return in excess of each portfolio’s neutral asset allocation model.
ESG investing in the new normal
While ESG momentum has been unstoppable, there are further indications ESG may even grow in importance. Throughout 2020, responsible investing products saw extremely strong flows. Morningstar reported that asset flows to sustainable funds were greater than $51.1 billion, up from $21.4 billion in all of 2019 or a year-over-year increase of 139 percent. Furthermore, flows into responsible investing products were 24 percent of all flows into stock and bond funds during 2020.
A critical factor for the enduring appeal of ESG as an investment strategy is that investment decisions are increasingly being made by women. According to an RBC Wealth Management client survey conducted in February 2020, female clients are significantly more likely than male clients to have a positive outlook toward, and want to learn more about, ESG investing.
According to the client survey, female clients are more than twice as likely as male clients to say it is extremely important that companies they invest in integrate ESG factors into their policies and decisions (23 percent of women compared to 10 percent of men). The survey also indicated female clients are significantly more likely to have a discussion with their RBC financial professional about ESG investing within the next year than male clients (60 percent of women compared to 38 percent of men).
In addition to high interest in ESG among women investors, younger investors in general have demonstrated a laser focus on sustainability issues. The number of people in these two demographic groups (women and younger investors) compared to the overall population, means that together they may have the sheer scale to shape the future of investing.
This demographic fact cannot be emphasized enough. With female clients and financial professionals playing ever larger roles in the investing world—and with Millennials preparing to both enter the peak earning years of their careers and to receive one of the biggest generational wealth transfers in history—ESG may not only be here to stay, many believe it may become a concept as fundamental to our profession as modern portfolio theory.
Choose an ESG service provider for your business
In addition to publishing its climate blueprint, RBC ranked number two in the global “Top 100 Most Diverse & Inclusive Companies” in the 2021 Refinitiv Diversity & Inclusion Index(Open in new window).5 The Diversity & Inclusion index ranks more than 11,000 publicly listed companies with environmental, social and governance (ESG) data, based on a composite of metrics collected from publicly available information sources that define diverse and inclusive workplaces.
Plus, in February 2021, RBC committed to provide $500 billion in sustainable financing6 by 2025 and net zero emissions in its lending by 2050. RBC achieved its initial goal for $100 billion in sustainable financing in 2020.
Together, the climate blueprint, third-party recognition and our public announcements regarding sustainability help demonstrate our sincere and steadfast corporate commitment to the principles underpinning environmental, social, governance investing.
As part of the RBC family of companies, RBC Clearing & Custody is proud to share the same values, and integrity that make RBC a global leader. And when you depend on us to help support your financial services business, you’ll experience the ESG in our DNA through our client-focused culture, the quality of the financial products we offer, the value of the wealth management expertise we provide and the responsive service you will receive.
To learn more about the RBC ESG Select Portfolio, as well as to find out about the many other ways we’ll help you make a difference in your business—and your clients’ financial lives—please contact us to speak with your business development manager.