Following her recent participation in a PCD webinar on the topic of ESG, we caught up with Melanie Griffiths to get her thoughts on ESG in the private client world. Here, in part one of a three-part ESG series, we discuss supply and demand for ESG investment products.
Before we begin, could you spend some time outlining what ‘ESG investing’ is?
Of course! There are lots of terms being thrown around, used somewhat interchangeably which can make the landscape more complicated than it needs to be.
‘ESG’ stands for environmental, social and governance. It is a way of investing which considers the way in which a company makes a profit - does it respect the environment, does it look after its employees, does it have a structure in place conductive to good decision making? Whilst it considers these factors as part of the investment process, it is typically in order to mitigate risk in the investment portfolio. For instance, a lack of regard for employees or the environment could result in a costly reputational nightmare, extortionate legal bills or inability to attract talent. Poor decision making / a failure to identify relevant risks meanwhile could run a company to the ground.
The terms ‘transition finance’ and ‘stewardship’ (a type of shareholder activism focused on ESG considerations) are used to refer to the use of one's influence as an investor / shareholder to help a company improve on the way it does business.
The term ’socially responsible investment’ meanwhile tends to refer to ‘exclusionary’ or ‘negative screening’ strategies - essentially avoiding certain ‘unethical’ sectors such as tobacco, arms or gambling. A challenge of such strategies is that it can be difficult to run the filter beyond the obvious - so for instance one may exclude gambling companies from one's portfolio, but own commercial real estate which has a casino as a tenant.
‘Responsible’ or ‘sustainable’ investments tend to be used as umbrella terms to refer to all methods of investing which consider not just profits but the way profits are made.
When investors go further and consider not just the way profits are derived, but also the wider impact of the consumption of a company's products and services, then it falls in the realm of ‘impact investing’. Impact investing is concerned with ‘what problem does this company solve?’ Typically, impact investment supports one or several of the United Nation's Sustainable Development Goals (SDG). In my mind, impact investing could also be described as ‘investing with purpose.’
So let’s take the example of a confectionary company - it could rate very well under ESG investing - treats employees well, uses recyclable packaging, grows organic sugar canes etc, however the existence of the sweets it produces is unlikely to make the world a better place / help achieve any of the SDGs, making it an unlikely candidate for impact investing.
Typically, one would expect market returns for ESG investing whilst impact investing may attract below market returns. To my knowledge neither ESG nor impact investing are defined through liquidity profiles but in practice ESG investing tends to focus on ‘liquid’ markets (e.g. publicly traded shares and bonds) whilst many impact investing opportunities tend to be at the illiquid end of the market (e.g. investments in privately owned companies or in private equity funds). To some extent, impact investing is a little like investing in R&D - there is a problem that needs solving and capital is required to explore ways to solve it, but it could take many years before there is a viable product / service to market. Of course, if the R&D investment is successful, the company will grow and may eventually become listed etc. so that what started out as an illiquid impact investment may eventually become liquid.
Generally speaking, I would say that ESG investors seek to invest in companies that do business ethically, whereas impact investors seek to use their capital to have a positive impact on the world (although they of course expect this to be achieved in an ethical way!). Both expect a financial return which distinguishes these investments from philanthropy. In practice of course, private clients may engage in a combination of ESG investing, impact investing and philanthropy.
It should be noted that the boundaries are somewhat blurred between various definitions, with some overlapping, so that others may use terms slightly differently to me. As the industry evolves, so do the definitions and new terms emerge such as ‘catalytic capital'.
How is the ESG space developing in the industry and what are your observations moving from banking and investment management into the fiduciary world?
I was previously a private banker advising private clients on their investments and borrowing requirements. I worked for 15 years at a major American bank where I saw the ESG landscape evolve from a topic which was considered the realm of ‘philanthropy’ – not investments - to what it is today with every investment manager professing to lead the way on ESG.
Coming from an investment management background, when I joined Equiom I was naturally invited to partake in ‘beauty parades’ - that is inviting investment managers to pitch for a chance to manage trust assets. I had never heard anyone other than my former employer pitch for investment business and was surprised to hear every manager lead with ESG regardless of whether any interest had been expressed for an ESG mandate. This surprised me as during my tenure as a private banker, not once had a client enquired about ESG (other than charities who have long been expressing a desire to invest their charitable endowment responsibly and sustainably).
What struck me, especially as I heard investment managers pitch, is that they did not enquire if our settlors / beneficiaries / family office representatives cared about the impact of their investment on the world and, if so, what in particular they cared about. It seemed to me like a real missed opportunity to engage and develop a meaningful relationship with parties to a trust. It also did not escape me that some of the wealth the investment managers were hoping to manage had been generated in industries that are positively ‘anti ESG’ (oil etc.) and perhaps the dialogue needed to be adjusted to take this into account.
It is important to acknowledge that on the one hand there are private clients with unique backgrounds, interests, and values, on the other hand there are investment managers trying to standardise their offering to achieve critical mass.
Could you tell us more about your perception of interest from clients vs interest from the industry in promoting ESG?
Being puzzled by the indiscriminate push for ESG from investment managers, I enquired from our trustees how much demand they had seen in the last few years from our settlors and beneficiaries for ESG investments. They outlined that while every investment manager seemed to incorporate ESG into their offering, the demand we were seeing from our settlors and beneficiaries was only just starting to emerge and, worryingly, when an interest was expressed, beneficiaries often walked away as they found the ESG landscape too confusing and were put off by the lower expected returns (which is puzzling - more on this in part II and III).
Research suggests that the biggest challenge to engaging private clients and their family offices on ESG and impact investing is ‘green and impact washing’, in other words: the challenge of knowing who and what to trust. It is key that advisors assist private clients, especially NextGen investors who tend to lead on these topics, to grow the skills and confidence to ensure they are not directing capital towards companies / funds jumping on the green bandwagon.
I can't blame private clients for being confused - during a beauty parade one day we were sold a particular name as a top ESG pick by one investment manager, only to be told the following day by another investment manager that the very same name was excluded from their portfolio on ESG grounds!
At this juncture, from what we are observing sitting at the intersection of families and investment managers, I am inclined to believe that the rapid rise of ESG is still more supply push driven (i.e. by investment managers) than demand pull driven (i.e. by clients). However, investment managers are responding to:
1) anticipated future demand from the next generation of wealth holders
2) actual and expected regulatory and legal developments forcing the agenda
The data does support that expected demand is rising (but it is still less than 30% of investors expressing a strong interest in ESG), it was always the younger generation who cared more about ESG issues but, until recently, they did not have significant assets. As wealth transitions to the next generation however, the expectation is that the demand for ESG will increase. One must balance that however with an awareness that one's view on the world tends to evolve over time, with priorities often shifting as one gets older. The babyboomers - as a generation - were also once very passionate about the environment and social justice, but it did not translate into meaningful demand for ESG investments once they came into wealth.
Interestingly, data indicates that the higher the net worth, the bigger the interest in ESG - as I will outline in part II of this 3 part series, aside from the desire to leave a positive legacy, this may partly be down to the fact that the higher the net worth, the higher the visibility and potential reputational risk associated with a failure to invest responsibly.
Source: Calvert Investment News Research
For more information on this topic, contact Melanie Griffiths or read more about important ESG considerations for private clients and practical advice to invest sustainably and responsibly in Part II and Part III of Melanie Griffith’s ESG series, coming soon.
This article has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The article cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Equiom to discuss these matters in the context of your particular circumstance. Equiom Group, its partners, employees, and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it.