This publication talks to a prominent ESG/impact-focused wealth management firm about the challenges and opportunities in its approach to managing portfolios.

(An earlier version of this interview was published on Family Wealth Report, sister news service to this one. We are running a series of features about environmental, social and governance-based investment across our news channels, and hope that the following comments prove useful to readers wherever they are based.)

US assets under management using ESG criteria stood at $12 trillion at the beginning of 2018, a 38 per cent rise in two years, and the equivalent of 1 in 4 dollars of the $46.6 trillion total managed in the US. By value, the US market is second only to Europe for socially responsiblie investing. Unearthing the explosive growth and how some of those dollars are being invested and reported, this news service spoke to Tiedemann Advisors.

The firm has around $18 billion under advisement and has been embedded in impact investing and associated approaches in the US market for more than a decade. With impact investing at the more stringent end of the ESG spectrum, and capital flooding in, there is concern about scaling with integrity. "While it’s a growing market, we’re still seeing demand from high net worth families and institutional investors like foundations, endowments, and non-profits outpacing the supply of high-quality, institutional impact investments," said Tiedemann's managing director and environmentalist, Brad Harrison.

How far advanced is the wealth management industry in embracing ESG? Are we at the early stages still or are there already signs that it is maturing and becoming “mainstream”?
Harrison: Impact investing has absolutely become mainstream. Most large banks, brokerage houses, and (strategic) investment advisory firms have or are building an impact offering for their clients. To give you a sense of the global scale we’ve reached, in April 2019, the Global Impact Investing Network (GIIN) published a report sizing the impact investment marketplace and identified over 1,340 organisations managing $502 billion (£385 billion) of “impact assets” worldwide.

Domestically, the US Sustainable Investment Forum (US SIF) has deemed $12 trillion of the $46.6 trillion of professionally managed assets in the US as “socially responsible”. As the market expands, we (and others) need to be sure that those making impact investments remain committed to the core characteristics of impact investing - and the market achieves “scale with integrity.”

As a follow-on from this, at what point can managers know whether they have reached full capacity of how much money can be deployed without pushing up valuations and creating the temptation for so-called mission drift? How scalable is ESG investing? There is lots of demand for ESG – is there enough on the supply side?
While it’s a growing market, we’re still seeing demand from high net worth families and institutional investors like foundations, endowments, and non-profits outpacing the supply of high-quality, institutional impact investments. Mission drift is always a concern, yet we’re seeing an increase in structures where fees and performance are tied to the impact outcomes, further aligning incentives with the impact the investor is seeking.

Within impact investing, what options are typically available for clients? Are there standardised types or is it still bespoke?
Impact investing typically falls into three categories in client portfolios. (1) Values aligned investments – these strategies screen out companies or sectors that conflict with an investors’ personal values. (2) ESG integrated investments – these strategies incorporate environmental, social, and governance “ESG” factors into the investment process, often as a risk management tool. (3) Thematic/place-based investments – these strategies support a specific theme (eg, education) or geography (eg, Detroit).

Over the years, we’ve noticed what may seem like a contradictory trend: both more standardisation across the above approaches and an increased amount of customisation within them. We have a more standard understanding of how to approach impact investing, yet the way in which these strategies are implemented continues to diversify.

What’s your assessment of the state of ESG reporting to clients today? Is it still primitive or getting more advanced? Does it convey information that’s clear and engaging? Can the data show if the investment manager is adhering to stated principles or deviating from a particular benchmark?
Tiedemann’s ultimate goal is to provide standardised ESG reporting just as we provide standardised financial reporting. This is still a few years off, but we do see light at the end of the tunnel. This is the first year where we are effectively running both financial reporting and impact reporting off the same reporting platform for our clients. Several industry-wide initiatives to standardise ESG data are showing real promise and practical application, including the Sustainable Accounting Standards Board (SASB), the work of the Impact Management Project, B-Analytics, and others.

Quite a few ESG investment strategies seem to fall into two camps: qualitative, requiring the manager to use his/her judgement, and quantitative, where certain metrics and data points are followed. Do you see a trend favouring one or more of such approaches?
Definitely quantitative, and the good news is that the volume of ESG data is growing exponentially and continues to improve. Consider that in 2007, Bloomberg, one of the largest data providers in the financial industry, provided almost no ESG data. Today, Bloomberg aggregates hundreds of ESG-related metrics.

While this is good news, it comes with a catch. Unlike financial data, ESG data is neither standardised nor mandatory. This results in selective reporting, uneven coverage, and hundreds of industry or company specific metrics. In our experience, the most successful asset managers use their own judgment to navigate the deluge of information and apply the impact metrics that are most additive and integral to their investment decision making. After all, the most effective investments are those where the financial and non-financial outcomes are inextricably linked.

Is there a risk that a lot of ESG investing will be heavily biased towards listed equities because these markets are public, have high levels of disclosure, and that investors could risk being underweight on bonds, private capital markets, real estate, etc? What can be done to address this?
No, we don’t see this as a risk. We think Responsible Investing/ ESG/and Impact Investing can be approached with the same asset allocation and portfolio construction philosophy as is used in traditional portfolio management. Oftentimes we see impact investors discount public markets as a lever to promote meaningful, widespread societal change in favour of some of the “sexier” asset classes like private equity, venture capital, and real estate. Case in point, the Securities and Exchange Commission recently required publicly traded companies to start disclosing the relationship between CEO compensation and that of the median employee. This has the opportunity to affect far more people and address a real income inequity gap, and an outcome of public discourse, ESG investment, and shareholder engagement within listed equities.

Are there regions of the world most suited to ESG investing or which exhibit particular attractions for ESG investors?
We believe that ESG investing has a place regardless of geography. That said, how ESG investing is practised can change depending on the region. For example, ESG metrics are more widely available in developed markets, like the US and Europe. As a result, it is easier for ESG managers to identify companies with strong ESG characteristics. In contrast, ESG data is less widely available in developing markets. Consequently, ESG managers tend to rely on direct engagement with company management to understand corporate practices on ESG issues.
 

How should a manager go about framing client expectations about the monetary returns that ESG investing makes possible? Have we got beyond the idea that there’s any sort of trade-off between ESG and making lots of money?
We’re not past it, and we actually think it’s a good debate. We adhere to our belief that ESG/impact investing can be implemented without sacrificing risk-adjusted returns (we’ve proven this). Case closed? Not exactly – because we also acknowledge that some clients actually do want to sacrifice investment returns in exchange for outsised impact. How is this done? Instead of maximising for a particular social, environmental, or financial return, we see value in optimising for all three, and this may mean intentionally taking a “trade-off” – but a calculated one.

What is your firm doing to train and educate staff about ESG to incorporate these ideas into how they talk to clients, analyse investments and manage portfolios? Are there talent shortages and skill gaps and how are you trying to deal with these?
We are integrating ESG and impact investing principles across the firm, at all levels. Contrast this with many banks, brokerage houses, and investment advisory firms who employ a dedicated team of “ESG specialists” who work in isolation from the rest of the core business. To integrate, and continue to stay at the forefront of this rapidly changing field, we host national retreats, regional trainings, attend conferences, meet regularly with investment managers, engage directly with our long-standing impact clients, etc.

We’ve also created an Impact Advisory Council made up of national experts in impact investing, like Jed Emerson and Richard Woo, to ensure we achieve that “scale with integrity” we discussed earlier. Another example is that the president of our firm, Craig Smith, serves as chair to our Diversity, Equity, and Inclusion Committee to ensure that our investment priorities mirror our internal operations.

When you start to talk to clients, who typically raises the ESG subject first? Have you noticed any shift over recent years?
A decade ago, clients were looking to dip a toe in this water. Today, we’re leading our clients and able to design fully-integrated impact portfolios across asset classes. As the business has grown and the impact field has evolved, what’s really changed is the breadth of issues we’re able to promote within portfolios. We’ve designed thematic expertise around a broad array of issues including environmental sustainability, financial wellness, education, diversity, equity and inclusion, and many more. We’re also seeing a dramatic shift in terms of who’s having these conversations with us and why.

As we’re undergoing a massive wealth transfer in this country, we’re seeing Millennials, and particularly women, driving impact within their portfolios. As we’re designed for permanence, we see this as both strategic business for us and promise for the future of the environment and society.

Is it getting easier to benchmark performance of ESG investments? Does the work of groups such as Global Impact Investment Network and others help?`
Our belief is that the performance of impact investments should be benchmarked against traditional industry benchmarks and that it may be counterproductive to the advancement of ESG/impact investing if the industry seeks to develop new impact benchmarks. There’s already enough confusion out there. Said differently, if we’re moving towards a future where “impact investments” are simply “investments” in client portfolios, we’ll get to that point faster without changing a universally accepted performance target.

The efforts at the Global Impact Investing Network (GIIN), Sustainable Accounting Standards Board (SASB), B-Analytics, Impact Management Project (IMP), and others are creating enhanced impact measurement tools which will allow us as investment advisors to go from measuring outputs (ie, numbers/metrics) to actual outcomes (ie, real environmental and social change).

There are several sustainable development goals laid out by the UN. Can all of these be easily incorporated into an ESG portfolio? If not, how can they be used?
It’s been estimated that it will take trillions of dollars of new capital to address the problems (and solutions) laid out by the UN Sustainable Development Goals. In 2017, Tiedemann made a strategic decision to align our impact investing themes with the UN Sustainable Development Goals, track them, and analyse our ESG exposures to them. The UN SDG framework is elegant in its simplicity: 17 high-level goals, colourful and iconic, inspiring (and at the same time a bit daunting!) to sum up our most pressing global goals in a simple framework. We’ve also learned that aligning with the SDGs is not enough – actually driving capital towards them is paramount.

We can debate that some of the SDGs are more “investable” than others (SDG 5 “Gender Equality” versus SDG 16 “Peace, Justice and Strong Institutions”), we recognise that the SDG’s are the most directionally important indicator we see out there.  

A lot of firms seem to be offering ESG funds and starting initiatives. Some of this may be sincerely motivated but clients might surmise that a certain amount might be about marketing and image building. What should firms do to break through such arguably healthy scepticism?
New investment talent can help drive innovation within the impact investing industry and competition is healthy. That said, we understand the scepticism and have met our fair share of new entrants who are “greenwashing” or “impact washing” as a marketing ploy. For those trying to break through the scepticism, showcase an experienced team, a thoughtful investment strategy, a “theory of change”, and a deep understanding of the systemic social and environmental challenges facing us today. And make it personal – because it is.

How should private banks, advisors suggest that clients integrate ESG with the rest of their financial “balance sheet”, such as their spending habits, management of operating companies, philanthropy, etc?
Effective advisors truly understand what their clients value, and this extends far beyond their financial goals. Impact investing is most effective when investors allocate the most appropriate type of capital (or asset class) to the problem they’re trying to solve. And it’s also important to acknowledge that impact investing isn’t the silver bullet for every social and environmental issue out there.

Take supporting the arts for example, an incredibly important part of the culture and fabric of place, yet an area which is probably better suited for philanthropy than investing. But something like affordable housing, a national crisis in many places, may have a place in an impact investor's portfolio – extending or providing leverage to traditional aid. If an advisor can help align their client’s financial picture towards their goals, not only will they likely achieve them quicker, they’ll create a more lasting and meaningful relationship with their client.