Advisors Still Skeptical About ESG Investment Performance, Want Proof 

Given the increasing demand for environmental, social and governance investing, one would think that products which incorporate ESG factors would be exploding, but that is not necessarily the case, a new report reveals.

Issues such as climate change, racial and gender equality, and data protection and privacy are among the global trends “piquing investors’ interest” in ESG factors, according to the June 2018 issue of The Cerulli Edge―U.S. Monthly Product Trends Edition.

And while advisors have begun to take notice and asset managers have prioritized incorporating ESG factors and criteria into their investment processes, conversations with distribution partners have not necessarily led to actual investment among advisors.

Cerulli’s analysis of the ESG market reveals that products (mutual funds and exchange-traded funds) deemed “ESG Integration” (excludes negative screening, impact investing and thematic products) accounted for less than 0.5% of the total market as of the third quarter of 2017.

Overcoming Hurdles

The findings confirm that one of the biggest hurdles for advisors in turning interest into actual investment, both by users of ESG and nonusers, is the perceived impact on investment performance.

Among ESG users, only 19% state that sustainable investment returns are a major factor driving their interest in ESG. At the other end of the spectrum, 75% of advisors who are not currently using ESG say that a negative impact on investment performance is a significant or moderate factor preventing them from implementing ESG. Other factors cited as reasons for advisors not using ESG strategies were difficulty benchmarking (64%) and investment models not incorporating ESG (61%).

This combination appears to indicate that from the advisor perspective, ESG factors are not tools that would help their portfolio generate alpha, according to the report. Equally challenging is that most advisors currently using ESG (92%) are seeing significant demand for ESG factors within U.S. equity products, which are under the most intense fee pressure and scrutiny of any asset class, the firm notes. In comparison, the next-highest asset class in demand for ESG is international equity, but only 33% of advisors are seeing demand for this product.

“Should asset managers begin to prove out that products integrating ESG factors into the investment process can not only provide comparable returns to those that do not, but in some cases outperform, it will be a big step in breaking into that non-user cohort,” the report suggests.

A recent survey by the firm finds that more than 50% of advisors have either used an ESG product in the past 12 months or will do so in the next 12 months. In addition, among advisors not using ESG products, only 14% state that a lack of understanding is a significant factor.

Even still, Cerulli emphasizes that at the advisor level, more education on exactly what ESG is and how it affects portfolios will be critical. The report notes that some firms are aware of this and are becoming more proactive in their approach.

For example, Morgan Stanley launched a sustainable investing education e-course last year that it placed on the desktop of all their advisors. In addition, Merrill Lynch recently launched a lineup of ESG-focused model portfolios available to both their advisors and investors. Cerulli notes that this is an “encouraging sign” considering that 60% of advisors not using ESG cite the lack of ESG incorporation within models as a challenge for them.

And given that 94% of asset managers say there is a high demand for ESG among Millennials, Cerulli notes that it makes sense for advisors to position themselves to capture the potential future demand of the largest segment of the U.S. population.

Better Data Needed

Similarly, a recent survey by the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Management found that a majority of individual asset owners are now pursuing sustainable investing to manage risk and drive returns, but they want better data.

The survey, which polled 118 public and corporate pensions, endowments, foundations, sovereign wealth entities, insurance companies and other large asset owners worldwide, found that 84% of asset owners are pursuing or actively considering pursuing ESG integration in their investment process. Of those, 60% began implementing ESG strategies in the last four years and 37% did so within the last two years.

And while asset owners cite risk management and potential for returns as top drivers of interest in sustainable investing, they still highlight the need for better data and investment information as a challenge to greater uptake. Proof of market-rate financial performance was cited by 24% of survey respondents as their top challenge to adopting sustainable investing, followed by 23% who cited quality ESG/sustainability data.

“The survey results identify a strong commitment to incorporating ESG criteria into investment strategies among asset owners,” said Hilary Irby, Co-Head of Global Sustainable Finance at Morgan Stanley. “However, there is still a gap between interest and implementation – with investors citing access to quality ESG data as a top concern.”

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