I am often asked by wealth advisers: “What do impact investors want from an adviser?”
Of course, in a time like this of tremendous volatility in public markets, they first want what all clients want: a steady hand at the wheel. But even in volatile and down markets, they want more than that.
What more they want varies, and we have created a simple framework to illuminate those differences in what sustainability-minded clients want: traditional, financial ESG, values alignment and impact contribution.
Traditional investing needs no explanation – the goal is to maximise risk-adjusted returns subject to liquidity constraints.
Financial ESG incorporates environmental, social and governance considerations, but only to the extent such considerations may affect the financial performance of the investment in the medium term. Most funds labeled ‘ESG’ – and, unfortunately, many labeled ‘impact’ – use this lens, and they suit the ‘financial ESG’ client.
Values alignment is where most sustainability-minded investors start. Often, the adviser has to help the client clarify their values. Advisers can add a lot of value to clients with this step, but it requires emotional intelligence beyond the typical adviser-client conversation.
Values-aligned portfolios typically have the following characteristics:
- Invested enterprises have a commitment to all stakeholders (customers, employees, suppliers, communities, shareholders, the planet)
- That commitment is measurable via voluntary reporting (such as an annual ESG report) or a minimum score on an ESG scoring system such as those offered by Sustainalytics or MSCI.
- The enterprises conduct activities the investor is willing to support, or are best-in-class examples in “dirty” sectors like fossil fuels
The first step is to understand which activities the client wants to support and which they do not. That is ‘values alignment’. Once advisers determine that, they can identify investments in their portfolio that do not fit their criteria, and then create a plan to replace them over time with investments that do. That step –divestment – is the first strategy: shift from investments that can cause harm to investments that avoid harm and even benefit multiple stakeholders.
Moving toward impact contribution
Clients who want their investments to help solve big world problems are aiming for a portfolio that achieves impact contribution. That goes beyond ESG, and usually means addressing one or more of the United Nations Sustainable Development Goals, which target measurable improvements across 17 key problem areas.
The first step toward constructing a portfolio with impact contribution is to identify the client’s investment thesis, or theory of change. Advisers can think of this as one or more ‘if-then’ statements about positive impact. For example: “If we help educate girls living in poverty, then we will improve economic outcomes for entire families.”
Many investors also have particular interests – clean energy, health, education or affordable housing, for example – that the portfolio can reflect as it moves from values alignment to impact contribution.
The next step is to identify and evaluate potential investments that fit the thesis and investor interests and create a plan to deploy capital.
Investments with impact contribution typically have these characteristics:
- They align with the client’s investment thesis, or theory of change
- They yield measurable social or environmental results that can be attributed to the investment.
- They create positive net impact (the benefits they contribute are not outweighed by any negative impacts that may also result).
Some values-aligned investments contribute to positive impact, but many do not. For example, an investment in a socially responsible accounting firm might fit with client values, but it is not making a direct impact contribution. There is nothing wrong with accounting – the world needs it – but it does not have a direct impact on poverty, education access, climate change or other big problems.
While historically asset managers have blurred these distinctions, that trend may be reversing. Recently BlackRock launched its Global Impact Fund with a remit to invest only in public companies that generate a majority of revenues from activities that advance the UN Sustainable Development Goals. At the same time, it changed the name of three funds that previously used the word “Impact” to use the word “ESG” instead. Until this kind of fund naming integrity is more widespread, advisers will need to read each prospectus carefully to properly understand the fund’s filters.
Engage with leadership
Across all three of these sustainable approaches – financial ESG, values alignment and impact contribution – are the core strategies of divesting from harmful companies and investing in responsible ones. But there is a third strategy in the impact investing arsenal – corporate engagement.
Most deep impact investors are sceptical of the impact they can achieve by merely holding investments in public equities. After all, they are buying in the secondary market, which means the issuer may not know or care who owns minority interests.
Engagement, however, changes that calculus. At minimum, this means voting proxies, and mounting proxy and influence campaigns at the strategy apex. Advisers can help by identifying managers of public equity products who vote proxies in accordance with ESG guidelines, and by illuminating engagement issues of particular concern to each client.
The wealth adviser journey
So that is the beginner sustainable investing cheat sheet – three styles and three strategies.
I will not pretend, however, that serving the sustainable investor is as easy as that. There is a lot to know, and as a business matter advisers should determine how far they want to go to serve this kind of client.
Advisers need to make two tough decisions:
- In the front office, whether to make values-aligned investment advice a core competency (which takes a significant investment in education, involvement, and learning with one’s own portfolio), or to form a relationship with an impact consultant who can help guide the values-alignment conversation with clients.
- In the back office, at least for independent advisers, whether to insource or outsource manager sourcing and due diligence. There are well over 100 new private and public funds and vehicles introduced into the ESG and impact ecosystem annually. For clients of modest sophistication, third-party rating systems from Morningstar, MSCI or Sustainalytics may narrow the universe of public funds, and the Impact Assets 50 might do the same for private funds. But for more sophisticated clients, sourcing and diligence will deeply inform the advisory conversation, enabling advisers and their clients to identify which impacts to target and measure and determine how to define success. That is a specialty, not a casual conversation.
Advisers should not let the challenges daunt them. They should start where they are, with this simple framework. Client demand for this skill set will grow, and those who start now will have an important head start.
Adam Bendell is CEO of Toniic, the global action community for deeper impact investing.
