According to Morningstar, the sustainable funds universe grew to 303 open-end and exchange-traded funds in 2019. Further, the number of conventional funds that claim to “consider” ESG factors has grown enormously – up from 81 in 2018 to now 564 funds.1
This “consideration” is an important factor, as the line between traditional and sustainable investments is becoming increasingly blurry. There is a certain level of “green” and “rainbow” washing in the impact space; that is, funds are marketing themselves as stewards of environmental and social impact but may not be embedding ESG meaningfully as a core tenet of the investment process.
The information provided in legal and marketing documents defining how funds use ESG insights is often incomplete and vague. This, coupled with a lack of standardized language, makes it difficult to understand the extent to which funds are truly adopting ESG. It also makes categorizing and comparing strategies challenging. Some funds with key terms like “ESG” or “sustainable” in their names don’t appear to be very different from the growing number of traditional funds now disclosing that they are considering ESG issues as part of their investment process.
How You Can Cut Through the Noise
Fortunately, there are valuable resources that can help cut through the noise and provide clarity. To start, research and ratings firms like Morningstar, MSCI, and FTSE Russell score funds to help indicate how well the underlying holdings are managing ESG-related risks and opportunities. These ratings can serve as a signal and starting point for further due diligence.
There are also financial services institutions that perform in-depth due diligence on ESG strategies in an effort to provide clarity for advisors and investors. For example, Envestnet | PMC conducts a four-factor analysis on ESG strategies within the traditional due diligence process:
- How is impact incorporated into investment policy and firm structure?
- How is impact integrated explicitly into the investment process?
- How does the manager report on social return relative to a benchmark?
- How does the manager engage with holding companies on environmental and social issues, and how effective is that engagement?
We collect this information through extensive conversations with key personnel, an evaluation of policies and programs, reporting, and proxy voting and engagement records.
More broadly, evaluating ESG strategies simply requires a targeted assessment to determine whether the fund is intentionally incorporating ESG factors into the investment process or is just adding a sentence to the prospectus. There is a wide range of approaches to impact investing, and instead of getting bogged down in the terminology, it can help to focus on evaluating intent and outcomes, to understand if the manager is explicitly stating an intent and then demonstrating the impact outcomes of the portfolio.
Conversations around impact investing offer the opportunity to connect more deeply with your clients, deepening relationships based on a better understanding of their personal interests, passions, and belief systems. From there, it’s an opportunity to provide value by aligning these considerations with their investment portfolios, so that the client portfolio can reflect who they are.
1. John Hale, “The ESG Fund Universe Is Rapidly Expanding,” Morningstar.com, last modified on March 19, 2020, https://www.morningstar.com/articles/972860/the-esg-fund-universe-is-rapidly-expanding.
The information, analysis and opinions expressed herein are for informational purposes only and do not necessarily reflect the views of Envestnet. These views reflect the judgment of the author as of the date of writing and are subject to change at any time without notice. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.