Contributed by: Jaclyn Jackson, CAP®
In honor of Earth Day, we’ve used the last couple of weeks to highlight environmental, social, and governance (ESG) investing. We began by explaining why ESG investing has grown in popularity. Then, we explored the variety of approaches used to support values-based investing. This week, we’ll cap our blog series with a Q&A style discussion about how The Center designs social strategies.
What are the first steps of building a values‐based investment strategy?
Construction fundamentals form the foundation of any investment strategy. First, we assure that asset allocation aligns with investment time horizons and investment goals. Even the most conservative research attributes 40% of investment performance to asset allocation. Liberal evaluations attribute as much as 90% of performance to asset allocation. Another fundamental philosophy applied to the construction process is being fee sensitive. The reality is that investment costs add up and the compounding effect of those costs diminish returns. Therefore, considering the costs of values‐based funds is a vital part of developing social strategies. In short, values‐based investing adds layers to the construction process, but it certainly does not change the foundational layers of that process.
What’s the difference between ESG Investing and Socially Responsible Investing (SRI)?
A: In the past when investment managers tackled values‐based investing, many used Socially Responsible Investing (SRI) methods. SRI takes a hard stance on eliminating industries from one’s investment strategy that do not match their ethics. However, there are consequences for taking such a black and white investment approach. Research has shown that completely eliminating industries from investment strategies undermines diversification and ultimately, erodes longevity. We strive to set clients up for the best possible outcomes (from a financial and values alignment perspective in this instance). For that reason, we prefer ESG investing; it has a values‐driven agenda, but doesn’t compromise performance (because investors can maintain diversification). At the end of the day, we want you to both uphold your values AND be able to retire. Our goal is to provide strategies that include longevity and diversification while protecting your values.
How we sift the wheat from the shaft when it comes to choosing ESG funds?
ESG investing is gaining popularity. As a result, we are seeing more and more ESG funds on the market. On one hand, it helps value‐aligned investors with diversification. On the other hand, it can set the stage for trendy, superficial products that don’t truly meet the needs of values‐aligned investors. To combat this, we make an effort to work with companies that have a reputation for walking the walk. Companies like Parnassus Investments, PAX World Funds, and Calvert Research & Management are companies that have demonstrated a longstanding commitment to values‐based investing. They actively engage with companies to improve behavior. Pax, for example, uses its shareholder voting power to advocate for better company governance.
How are ESG product inconsistencies navigated during the strategy construction process?
When faced with complex decisions, we ultimately consider what brings the most value to clients. Last week we learned, all ESG funds aren’t created equal. Values-based funds can excel by some measures, but fail by others. It’s a tough negotiation to build a strategy and as a result, there is some give and take involved. When faced with complexity, we launch internal research initiatives to identify best practices. Ultimately, data dictates what we believe is the right thing to do for the overall strategy.
Admittedly, we’ve only scratched the surface of how The Center develops social strategies. Luckily, the conversation doesn’t have to end. We are happy to chat more about our process and support you in integrating values into your investment plan. We hope you enjoyed our ESG blog series and have a Happy Earth Day!
All investments are subject to risk, including loss. There is no assurance that any investment strategy will be successful. Asset allocation and diversification does not ensure a profit or protect against a loss. It is important to review the investment objectives, risk tolerance, tax objectives and liquidity needs before choosing an investment style or manager. Sustainable/Socially Responsible Investing (SRI) considers qualitative environmental, social and corporate governance, also known as ESG criteria, which may be subjective in nature. There are additional risks associated with Sustainable/Socially Responsible Investing (SRI), including limited diversification and the potential for increased volatility. There is no guarantee that SRI products or strategies will produce returns similar to traditional investments. Because SRI criteria exclude certain securities/products for non-financial reasons, utilizing an SRI investment strategy may result in investment returns that may be lower or higher than if decisions were based solely on investment considerations. Utilizing an ESG investment strategy may result in investment returns that may be lower or higher than if decisions were based solely on investment considerations. Raymond James is not affiliated with and does not endorse the opinions or services of Parnassus Investments, PAX World Funds, and Calvert Research & Management.