By Kai Upadek.
This article first appeared on Financial News on June 23, 2020.
The winds of change are blowing briskly through global markets.
The dominant ideology governing corporate behaviour since the 1970s has been that companies have little responsibility to anyone but their shareholders. As economist Milton Friedman once quipped, "the business of business is business".
But that notion is now being challenged by a movement known as "stakeholder capitalism", which posits that companies must act in the best interests of a variety of groups beyond shareholders — workers, customers, suppliers and local communities among them.
The movement had already been gaining strength for a few years. The events of the past few months — the coronavirus pandemic, the forced shutdowns of economies around the world and violent clashes in the streets of US cities over race relations — have added more urgency, not only among investors but corporate leaders as well.
This presents both challenges and opportunities for wealth managers. The challenge is to reorient their offerings to account for a new reality in which shareholders aren't the sole driving force of corporate behaviour.
The opportunity is to be out in front by creating new types of environmental, social and governance (ESG) investment products that cater to the growing demand for stakeholder-friendly investments.
Interest in ESG investing has grown significantly in recent years among institutional investors such as university endowments and public pension funds, and now individual investors are taking notice as well.
In all, Oliver Wyman projects that ESG investments, which clocked in at about $4tn among high-net-worth clients in 2019, will grow by 18% a year to $9tn by 2024.
Concerns over climate change have been the main driver of the ESG investment movement, but the "G" — governance — is becoming increasingly important. As the violence in US cities has shown, many people, especially young people, are unsatisfied with the progress of the racial equality movement and are likely to push harder for more representation of racial minorities and women on corporate boards.
Social and climate issues aside, there is a growing body of evidence that investors can build portfolios with positive ESG attributes without compromising investment returns.
One recent Morningstar report, for example, analysed returns from stocks over a 10-year period and concluded that investors can build global ESG-aligned portfolios without sacrificing risk or returns.
So how can wealth managers respond to the growing demand for ESG investments? In a word, carefully. There is a risk, after all, that a full embrace of ESG could alienate some customers who seek only to maximise returns.
Firms would be wise to present two tracks, with one track looking largely like it does today and focusing on traditional investment strategies and the other being ESG-focused, while giving clients the ability to choose from both. There are four broad roles that wealth managers can play.
First, they can help clients define their sustainable investing goals and objectives.
Are they looking for strategies that screen out poorly performing companies, or consider ESG factors as part of broader investment criteria?
Does the whole portfolio need to be sustainable, or just part of it? Is the client interested in "impact" investing beyond financial return, in which investment is targeted to companies deemed to create constructive societal outcomes, such as clean energy?
In this part of the process managers should communicate to clients the data they use and how it is factored into decision-making.
Next, wealth managers can help clients implement these goals and objectives in their portfolio. This is where progress has already been made, but wealth managers can go further in providing a product offering that covers the breadth of asset classes and sustainable investing approaches clients wish to use.
In particular, some wealth managers likely will offer specific impact investing products. The key is to use their institutional relationships to find proprietary investment opportunities from which clients can choose, based on the investment themes with the most relevance to them.
Wealth managers also can report on key metrics to demonstrate the impact alongside the financial performance of clients' investments.
For example, they could report the greenhouse gas intensity of an investment portfolio, along with specific metrics related to impact investments in the portfolio.
Finally, wealth managers should play a key role in resolving some of the hurdles hindering the growth of sustainable investing, particularly around the lack of clarity around ESG definitions.
They should participate in industry discussions to create a common set of practices that can systematise product quality and foster greater acceptance of sustainable investments.
To be sure, there is no one-size-fits all answer for how wealth managers can participate in ESG. They must consider their target clients, current capabilities and ability to invest first and foremost. Nevertheless, delivering a holistic, well-conceived ESG component can help firms differentiate themselves in a time of great change.