Investment advisors have been slow to embrace the movement towards SRI investing. Even as I’ve described the SRI tipping point in a previous post, the great majority of this movement has come from institutional investors. Most individual investment advisors, however, have been hesitant to follow.
Perhaps to distance himself from many of those in the SRI field who lead with their heart, Jason Voss of the CFA Institute assumed the perspective of an unemotional economist while writing his recent blog post supporting SRI investing.
When I emailed Voss to thank him for sharing these helpful insights, he responded by saying, “Thank you for your kind words about the series. I think it has alienated some of my fans because they believe I am a quisling.”
“A quisling”? I did a quick search online and learned that many financial advisors now see Voss as a traitor to fundamental investment management practices. The irony of all this, of course, is that Voss was writing from his position as the director of the CFA Institute, and the CFA exam now includes a focus on ESG (Environmental, Social and Governance) factors. The response Voss received confirms recent research highlighting the fact that investment advisors’ interest in SRI/ESG investing lags far behind investor demand. This chart from Morningstar combines results from two studies that contrast investor and advisor interest.
So why do investment managers continue to resist this growing demand? While many cloak their resistance in flimsy philosophical arguments, I find that the majority of this resistance is actually very practical. Most investors recognize that SRI investing adds many layers of complexity and, thus, they question their ability to offer a solution in the face of this complexity. SRI advocates—myself included—are guilty of covering up just how much time and resources are needed to pursue SRI effectively. Because of this, I’ve composed a list of the three most significant reasons that keep investment managers from diving in to the world of SRI investing. Here they are:
Reason #1: INVESTMENT BREADTH
In the past, managers could argue that fees were too high and SRI strategies lagged the markets. Today, there are plenty of reasonable cost and competitively performing investment options to choose from. But this is only true in the core strategies. Most managers that I know distinguish themselves from the standard target date fund strategies by tailoring their investment strategy to emphasize sectors, countries, or fixed income strategies. In these more targeted strategies, SRI overlays are often too expensive or virtually nonexistent. In this case, an investment manager either needs to adapt his or her investment strategy or come up with some hybrid approach, which creates a different set of return experiences for their SRI and traditional clients. The real risk here? One set of clients will possibly feel alienated, underwhelmed, or confused by the mixed messaging.
Reason #2: ADVOCACY EFFORTS
SRI investors typically argue that it’s not enough to passively hold stocks and funds. We believe that investments managers are responsible to assist investors in governance oversight by voting their proxies and by staying engaged in shareholder resolutions. I recommend that managers and investors attend at least one shareholder meeting per year, even if it’s just to grab some free snacks and shake an executive’s hand. At minimum, a typical investment firm would require a part-time position to respectably manage these activities. One remedy to this human resource suck is to stay away from owning individual stocks and, instead, invest in funds that have a confirmed shareholder advocacy track record.
Reason #3: MATERIALITY DIFFERENCES
Once you engage investors in factors beyond risk and return, you may feel that you’ve opened up Pandora’s box of differing opinions on value. Some SRI advisors focus on environmental sustainability, while others emphasize workforce development and local communities. Still others emphasize governance practices like CEO pay, board diversity, and experience.
The emergence of ESG scoring is an attempt to lump all of these non-financial value and values factors into one measure of corporate citizenship and reputational risk. As I’ve noted before, the ESG marriage doesn’t always serve everyone’s interest. Rather than attempt to research all of these factors personally, most firms increase their ESG research budget. But the friction here isn’t all about time and money. Just like the DIY repairman who goes to Home Depot for a replacement shower head only to return home defeated and empty handed, investment advisors can also feel overwhelmed by the possibilities and unable to take the first step forward.
At this point, my own readers may come to believe that I’m a quisling myself. However, my point isn’t to push anyone away from SRI investing, but rather to describe the very real reasons why investors are reluctant to embrace this form of investing. All of these extra time commitments and research costs point to smaller margins and—whether we like to admit it or not—margins are a very powerful motivator, especially among the investor crowd. We’ll continue to see a small number of SRI specialists who plant their flag in this space, but I expect that most firms with less than ten advisors will find it too economically challenging to make a serious effort here. Larger firms, however, will benefit because they can afford to dedicate teams who will specialize in SRI investing and they’ll be able to keep this messaging separate from their core clients. That’s just the way it is—for now, at least.