Clearstead convened its second ClearPoint roundtable last week at the Union Club of Cleveland, exploring industry trends in institutional and private wealth management. Titled,  “The Cost of Conscience: Charting ESG Roadmaps for Institutional Portfolios,” the roundtable brought together top experts in academia, financial services, and law to help institutions and individuals navigate the fiduciary rules of ESG – what Clearstead terms Responsible Investing.

The discussion was moderated by Bob Stein, serial entrepreneur and director of ESG programs at John Carroll University. It began with a snapshot of the ESG industry by BrownFlynn Principal Consultant Jennifer Andress:

“For decades, companies have been asked about or have been focusing on diversity, inclusion and sustainability – this is ESG,” Andress said. “Now, from Bloomberg to SASBY, companies are being watched by ESG analysts and embracing the fact that efficient practices and mitigating risk strengthens the health of business.”

Priya Parrish, CIO and managing partner at Impact Engine, described the difference between ESG and impact investing before remarking, “it seems like the industry is changing the name over and over.”

“Impact investing is about your intention; what you intend to impact with your dollars. It is a verb of action,” she explained. “But while impacting a certain social and moral cause such as the environment by investing in ‘green’ companies is the main goal, investment performance still matters. Historically, consultants managing ESG were not money managers, but that’s changed. Today, more and more investment firms are managing ESG and attracting top talent money managers who know how to drive performance.”

The Dual Mandate

“According to fiduciary legal principles, focusing on the return should always be the anchor when it comes to institutional investing,” said Robert N. Rapp, Professor of Law at the Case Western Reserve University School of Law, referencing the Department of Labor’s (DOL)
ERISA ruling last year. “This doesn’t mean that an investor can’t take into account ESG factors. It can be part of a decision-making process, but it shouldn’t drive it.”

In clarifying how ESG investments should be taken into consideration under ERISA, the law that governs fiduciaries, the DOL acknowledged last year that ESG factors “may have a direct relationship to the economic and financial value of an investment” and cautioned that “ERISA fiduciaries must always put first the economic interest of the plan…”

But can ESG investments outperform standard risk-adjusted returns? According to some roundtable panelists, the answer is “yes.” For institutional advisors who have a longer investment horizon, ESG is a very material strategy, according to Matt Zalosh, chief investment officer of Boston Common’s international strategies.

“ESG asset managers are able to engage with companies and push them to drive value,” said Zalosh. “International strategies have outperformed standard benchmarks and we’ve seen high returns on companies that are raising the bar when it comes to nutrition, better packaging, healthier products – something more in demand in Europe and Japan, but starting to catch steam in the USA.”

At Clearstead – which provides both institutional and private clients with a Responsible Investing strategy – John Evans, who heads up Responsible Investing, sees an increased desire from institutions and families who want to find investments that align with their long-term values or drive social or economic change.

“The goal of our process is that a Responsible Investing strategy will have a neutral effect on portfolio performance, proving that aligning investments with mission can be both a financially and morally sound approach for many institutions,” said Evans. “The hardest part for institutional clients is getting started. Our questionnaire walks committees through the ESG options, sometimes anonymously, so that a decision to start somewhere if desired can be made.”

In addition to investments with strong returns, Andrew Watterson, KeyBank’s head of sustainability, believes that companies who are transparent with ESG analysts on items such as employee ownership, labor practices, and sustainability provide investors with a level of risk mitigation that may translate to safe and prudent investment choices.

“How a company treats its employees and invests in items like product health and safety isn’t something you can find in a 10k,” said Watterson, head of sustainability for KeyBank. “But it’s this focus on the longer-term items that will mitigate risk down the road.”

And perhaps the most insightful takeaway from the panelists came from Parrish who reminded the audience that when it comes to performance, “there’s no such thing as a best risk-adjusted return,” which drives the point home that, while ESG investments might imply lower expected returns, the responsibility is on the advisors who must work harder to find alpha-generating managers.

Key Insights and Takeaways:

  • ESG will continue to grow, and measurement of a company’s ESG ratings will become imbedded in the investment process. Think of it as another factor when you’re evaluating a company’s future growth.

  • “Follow the talent and you’ll find alpha:” Companies are pressured from multiple avenues to adopt ESG practices and report on them, but perhaps the most important drive is coming from talent attraction. Millennials and next-gen college graduates want to work for companies that have a higher purpose.

  • Companies are embracing the fact that efficient practices and mitigating risk strengthens the health of the business.

  • There’s no such thing as the best risk adjusted return and biases will always drive investment objectives.

  • The private equity market asset class is prime for more ESG investments. With roughly 20 percent of American jobs in this market, there’s a huge potential for impact. While impact investing is gaining foothold in private equity, there were only six out of 2000 fund closings last year.

 

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