ESG takes its place as a standard form of customization
Support for ESG (Environmental/Social/Governance) constraints has been part of our offering from the moment we launched. This was in keeping with our larger mission of democratizing the type of portfolio management services that were once the exclusive preserve of ultra high net worth investors. However, ESG constraints have always been a bit of an outlier — sort of the ugly duckling of account customization. We think that’s changing.
Everyone understands that tax management is a valid part of portfolio management; security and sector constraints, whether motivated by return beliefs or a desire to counterbalance a client’s external risk exposure, are uncontroversial; customized asset allocations and product choices are near universal. But not everyone accepts ESG constraints as “proper” customization. Here’s why: every other form of customization has (or should have) something to do with higher risk-adjusted after-tax returns. Except ESGs. Arguments have been made that ESG constraints are good for returns — that companies that fail ESG screens will underperform in the long run — but that’s not the reason most investors choose to have ESG constraints. They’re doing it because they think it’s the right thing to do. It’s not about “normal” investment criteria.
And that’s what makes ESG constraints stand out — the “ugly duckling” of account customization. But it’s worth remembering that in the original fairy tale, the “ugly” duckling turns out to be a beautiful swan. I sometimes think ESG customization may be about to have its own swan moment — an ugly duckling no more. When an advisor’s value proposition is focused on beating a benchmark, ESG constraints may be viewed as a distraction. But product-oriented and performance-oriented value propositions are receding in favor of goal-based approaches, where ESG investing fits comfortably. It’s not that ESG constraints increase the probability of meeting goals. They become a goal in themselves. After all, wealth is always just a means to an end (though this point often gets lost). Wealth is there to make our lives better. And part of a good life is living up to our own principles along the way. No one would question an investor having a charitable goal. So should investing in accordance with one’s ethical beliefs be viewed differently?
Among our own users, we’ve seen ESG usage more than double over the last five years, albeit from a low base — from about 2% to about 5% of accounts. That’s still fairly low, but ESG usage continues to grow. Already, more than half of all our advisors use ESG constraints on some accounts. And we’re now hearing from prospects who reach out to us with explicit business requirements to add ESG support. That’s new. We’re on the road to having ESG customization become a standard part of every practice — an ugly duckling no more.