THE notion of applying environmental, social, and governance (ESG) criteria to the investment process is increasingly gaining momentum among high-net-worth (HNW) investors. Cerulli Associates’ latest report, US High-Net-Worth and Ultra-High-Net-Worth Markets 2019: Multigenerational Shifts in Wealth, finds that as much as 58% of HNW practices currently use ESG/socially responsible investing (SRI) and plan to further increase their allocations in the next 12 months.
“The concept behind ESG resonates with HNW investors due to their comfort levels in investing in innovative areas that provide impact and because of their deliberate focus on sustaining and protecting their wealth,” states Asher Cheses, a research analyst at Cerulli.
Among those leading the movement toward ESG investing are multi-family offices (MFOs), many of which are set up to help families pass down their wealth across multiple generations. “For many family offices, sustainable investing has become a core component of their investment process that unites family members around common values and beliefs,” adds Cheses.
While many HNW practices started out with negative/exclusionary screening (e.g. tobacco, weapons), they have since evolved to offer a wider range of strategies to their clients, including ESG integration and impact investing.
Furthermore, the number of HNW practices incorporating ESG into their investment process is positioned to increase in the coming years as firms continue to use it as a conduit to the next generation.
According to Chayce Horton, an analyst at Cerulli, “Younger investors are increasingly looking to align their investments with their personal values,” including a new generation of socially and environmentally conscious entrepreneurs who are putting their money to work in constructive ways. “As next-gen investors begin to inherit wealth and become more involved in their families’ investment decision-making processes, their interest in socially responsible investments presents a significant opportunity for the emergence of ESG strategies,” adds Horton.
As more investors look to align their portfolios with their values, understanding the driving factors and motivations behind clients’ ESG interests will become increasingly important. According to Cerulli’s survey of HNW practices, the most important reasons for using ESG/SRI strategies include environmental concerns (69%), the desire to make an impact with their wealth (54%), and ethical concerns (52%).
In addition, nearly one-quarter (22%) of HNW practices using ESG indicate that generating sustainable investment returns is a significant factor for their clients. “HNW investors are starting to realize that investing for financial return and investing to make an impact are not mutually exclusive,” adds Cheses.
However, as ESG moves toward mainstream investing, there are still several factors in play that may be preventing investors from adopting ESG solutions across their portfolios. One of the main inhibitors to adoption—according to 55% of HNW practices—stems from the sentiment that ESG strategies do not fit into client investment policy statements.
“While concerns around incorporating nonfinancial conditions into a client’s investment policy are warranted, advisors should look to explain to clients the benefits of ESG integration, within the context of improving performance and mitigating risks,” explains Cheses. In addition, HNW practices cite high cost (40%), difficulties measuring impact (40%), and lack of track record/performance (30%) as barriers to ESG adoption.
“Given that ESG is still in the early stages of development, there is a lack of available data and standardization in measuring an ESG strategy’s effectiveness,” notes Cheses. “Therefore, conducting proper due diligence and accurately measuring the environmental and social impact of these investments has remained a significant challenge for HNW practices exploring the ESG space.”
Asset managers that can present thought leadership, provide transparent data and measurement tools, and assist HNW investors in incorporating ESG factors into their portfolios will stand to benefit. While secular social and environmental trends among the next generation of wealthy investors continue to drive appetite for ESG solutions, barriers exist for many HNW practices and will require asset managers to provide more thoughtful education on the merits of integrating ESG into the investment process.