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Debunking ESG Myths Part 1: The Fear of Sacrificing Financial Returns

Published on

April 14, 2021

In this three-part blog series, learn more about the biggest myths when it comes to ESG investing and your role in debunking these myths for your clients.

While there is no doubt about the increasing levels of interest in ESG investing, there are still common misconceptions and myths we believe are holding investors back from investing according to their values. There is a responsibility for advisors to not only understand the value of ESG for their clients but to take the time to bust the myths that might be clouding their understanding.

In this three-part blog series, we outline 10 of the biggest myths when it comes to ESG investing and facts you can use to debunk these in your next client call:

Part 1: The Fear of Sacrificing Financial Returns

  • Myth #1: Investors must sacrifice financial portfolio performance with ESG
  • Myth #2: ESG doesn’t add value to the investment process

Part 2: The Future of ESG Investing

  • Myth #3: ESG investing is just a trend
  • Myth #4: My clients don’t care about ESG
  • Myth #5: Only millennials and women are interested in ESG
  • Myth #6: ESG investing is only about the environment or screening out “sin” stocks

Part 3: Understanding the Back-Office Operations of ESG Investing

  • Myth #7: There’s no place in my portfolio for ESG investments
  • Myth #8: ESG investing is too difficult
  • Myth #9: There are no standards for ESG reporting
  • Myth #10: You can't effectively measure sustainability and impact

Myth #1: Investors must sacrifice financial portfolio performance with ESG

Fact: ESG investing has outperformed or performed in line with traditional investments.

Client talking points:

This myth is one of the most pervasive when it comes to ESG investing. Even some millennials, who are often credited with the rising interest in ESG investing, are holding off from investing according to their values due to this misconception of financial risk. After all, most investors are looking for financial gain through their investment decisions. Anything that might threaten that gain could understandably be tossed aside. The idea that one can invest according to their values and still see financial gain may not be fully accepted in the industry.

A big reason for this is that at the beginning, ESG strategies centered around excluding “sin stocks”, or stocks in tobacco or alcohol for example. While ESG has expanded beyond the “sin stock” exclusion, as we will talk about in Myth #6, this is still a misunderstood conception of what ESG investing looks like. As a result, many investors may see ESG investing as an exclusionary practice that might lead to underperformance in the broader market.

However, as we’ve talked about in previous blog posts including “What COVID-19 Teaches Us About ESG Investing” and “How ESG Is the Growth Opportunity of the Century”, this is simply not the case. Portfolios composed of companies with high ESG scores have systematically outperformed portfolios of companies without disclosure practices and sustainability reporting.

According to Morningstar, in the first quarter of 2020, 24 out of the 26 ESG index funds the firm tracks outperformed their closest conventional counterparts. Of 206 sustainable equity and ETF funds in the US, 44% ranked in the top quartile, 70% in the top two, and only 11% in the lowest quartile (based on year-to-date performance net of expenses).

When it comes to COVID-19, companies with a proven commitment to their social and governance metrics are not only recognized for stepping up to the monumental challenge but are also proving themselves among the best prepared for market shocks. This resilience of ESG investing in the context of the ongoing pandemic’s impact on public equity markets demonstrates how inaccurate this myth of underperformance really is.

Myth #2: ESG doesn’t add value to the investment process

Fact: ESG investing is a good insight into the market’s risks and opportunities as we navigate the future of the financial market in today’s new normal. It’s also a personally fulfilling opportunity to align your portfolio with your values.

Client talking points:

Many investors believe that ESG investing has little long-term value when it comes to financial outcomes, risks, and opportunities. However, ESG investing is all about thinking long-term. By implementing disclosure practices and sustainability reporting, a business can better track and limit its risks and opportunities for the future. Outside of financial performance, ESG also offers a sense of individual fulfillment when incorporating ESG considerations into your process.

It can be personally, intellectually, and financially rewarding to consider a company's resilience and long-term positioning for sustainability. Not only is your portfolio offering you personal value by understanding the impact of your investments, but ESG also can build portfolios that will be more resilient to market instability and sociopolitical or environmental risks over time.

In a 2019 MSCI study, for example, ESG quality affected stock performance, risk, and valuation. Companies that had higher ESG scores typically resulted in higher profitability, lower risk of drawdowns, and lower systematic risk overall. In 2020, a year marked by market instability and sociopolitical disruption, ESG funds typically outperformed others. This demonstrates the resilience of ESG and the value it can add to your portfolio.

In September 2020, the Commodity Futures Trading Commission (CFTC) put out a report that stated, “Climate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy.” Their recommendation in the report is that all U.S. financial regulators “should move urgently and decisively to measure, understand, and address these risks”.

Climate change is and will continue to impact the economy. The opportunity to evaluate those risks to your portfolio through ESG investments is incredibly valuable now and for the future. Europe’s new ESG regulations demonstrate that sustainability risk management and increased sustainability transparency are the future of the industry.

This is especially the case with a Biden administration that has made it clear that climate change policies are the number one priority. Given this, a company that is proactively thinking about its impact within any or all of the E, S, or G buckets is going to be better prepared for market volatility and increasing social pressure to address these challenges. It’s not just about aligning with an ethical or moral worldview, it’s risk management.

Investors that consider a company's investment worthiness from these multiple angles — financially, sustainably, and personally — are not only positioning their portfolio to weather future risk but are also more engaged, better-informed investors who get to experience incredible personal value within their portfolios.

Starting the ESG conversation

As a financial advisor, you are well-positioned to fill the knowledge gap when it comes to ESG investing. This all starts with a conversation between you and your clients. Begin to understand both their values and goals as well as their questions and fears when it comes to ESG investing. Learning how to talk to your clients about ESG is not always easy, especially because every conversation will look a little bit different.

Start the conversation about the myths that are holding them back. Help them understand that there is a solution that can better align with their values without having to sacrifice financial gain. By busting those myths and providing a higher level of customization aligned with their values you not only build that relationship but position yourself as a needed service provider.

Learn more about talking to your clients about ESG investing and how to get them on board. Plus, stay tuned for parts 2 and 3 as we continue to bust more myths in the ESG landscape.

Investment in securities involves the risk of loss. Past performance is no guarantee of future returns. One cannot invest directly in an Index. Any opinions, estimates and forecasts offered in this document constitute judgment as of the date of the materials and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information contained in this document to be reliable but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and it is not intended to provide and should not be relied on for investment, accounting, legal or tax advice. OpenInvest may not have verified (and disclaims any obligation to verify) the accuracy or completeness of any information herein that has been provided or obtained by third parties.

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