As more investors express interest in socially responsible investing, investment advisers are turning to exchange-traded funds and mutual funds focused on shares of companies with strong environmental, social, and governance (ESG) practices.
But why stop there? Enterprising advisers see an opportunity to stand out from their peers by embracing sustainable investing in new ways. Rather than divvy up client assets among popular products from financial services giants, some advisers seek to differentiate themselves by customizing ESG portfolios to suit each client’s preferences.
The sector is certainly hot. ESG funds raked in a record $13.5 billion of net new money from investors during the first three quarters of 2019, according to investment researcher Morningstar.
These funds largely aim to produce similar risk and returns to standard indexes while investing in companies with high ESG ratings. Yet keep in mind there are many inconsistencies in how different rating firms determine what constitutes a socially responsible company.
Accordingly, investors may balk at an asset manager’s failure to screen out certain sectors (“Why are oil-and-gas companies included?”) or favor certain criteria (say, companies committed to gender equity) over others.
“Most clients have specific issues they care about,” said Aaron Brachman, a certified financial planner in Washington, D.C. “It’s emotional to them.” That’s why Brachman often builds ESG portfolios for clients based on the issues that they deem most important to them. Naturally, this takes more time and effort than simply buying an ETF.
For starters, clients who are laser-focused on one single criterion pose a challenge. Brachman warns them about the risk of excessively narrowing the scope of their investments.
“We allocate percentages based on the themes that the client is interested in,” he said. “But if they have a really strong belief in just one theme, we have to balance that theme with meeting the client’s end goal of retirement planning, saving for [their child’s] college” and other long-term objectives.
Once he gains the client’s buy-in, Brachman faces another obstacle. Socially responsible investing remains a fluid concept with shifting trends and societal concerns.
“Building a custom portfolio is not terribly efficient,” he said. “It’s still pretty clunky to get accurate data on what the social impact of a customized portfolio will be. There’s no uniform way that companies report their sustainability data. And you have to monitor it on a regular basis.”