The surge in energy stocks and reversal of fortune for technology stocks has been an important factor in ESG-focused fund struggles this year. It may be fair to argue that ESG investing was neither inherently great in 2020 nor inherently bad in 2022.
‘Values’ and ‘Value’ May Not Have the Same Meaning
Explaining the distinctions between terms is an important aspect of the advisor-client dialogue. Many clients seek alignment between their investments and personal values. Exclusionary approaches eliminate individual holdings or market sectors that investors wish to avoid. For example, many climate-focused investors embrace strategies that exclude traditional energy and utility stocks.
Exclusionary approaches are commonly selected for clients who prioritize “values” alignment for their investments. Advisors should understand the trade-offs implicit in exclusionary approaches. For example, tobacco stocks represent a very small part of the S&P 500 index, mitigating the potential opportunity cost of avoidance. In contrast, more than 20% of companies in the S&P 500 have some involvement in animal testing, so a blanket avoidance of animal testing would significantly reduce the investment opportunity set.
Many asset managers incorporate ESG factors into the assessment of the appropriate intrinsic “value” of an investment. ESG factors are an important, but not the only, investment consideration for many of the world’s largest and most influential asset managers.
Asset managers such as Pimco, GMO, T. Rowe Price, TIAA, Calvert and Parnassus incorporate ESG factors believed most likely to positively influence financial performance into traditional financial analysis. According to Parnassus CEO Ben Allen, “ESG done right can have a positive long-term impact on performance.”
Asset managers that incorporate ESG factors cite Wells Fargo, PG&E and Experian as companies in which ESG shortcomings created a material decline in the intrinsic value of the stock. According to EY Global Deputy Vice Chair Katie Kummer, “ESG information can serve two purposes: to assess financial risk and to assess social impact. These uses are not mutually exclusive but are easily confused.”
Advisors play a vital role in providing education, helping clients decide what approach or combination of approaches best aligns with the client’s preferences. Some clients may prefer the values alignment provided by an exclusionary approach; ESG-focused “value” strategies may resonate more with other clients.
Another key role for the advisor is to look beyond hype and sound bites to assess the authenticity of different investment offerings and merits of arguments about ESG investing. Ultimately, a well-informed client is more likely to remain a satisfied client.
Daniel S. Kern is chief investment officer of TFC Financial Management, an independent, fee-only financial advisory firm based in Boston. Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds.
Daniel is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. He also sits on the board of trustees for the Green Century Funds