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Record flows to ESG funds means that advisors will have access to better tools to analyze product effectiveness and will be able to construct customized solutions for their clients.
ESG investing is the hottest trend in asset management. Despite YTD fund outflows of $167 billion for all funds and ETFs, ESG-related funds saw record-setting inflows of almost $21 billion (through June 30), nearly matching their total 2019 fund flows of $21.4 billion.1 In 2019 alone, total ESG fund flows were four-times higher than the previous calendar year record.2

Investors’ embrace of ESG investing is also getting the attention of companies and regulators. In August 2019, the Business Roundtable announced a new, expanded “Statement on the Purpose of a Corporation,” committing its companies to benefitting all stakeholders and not just shareholders. It was signed by 181 CEOs, many representing some of the largest companies in the world. Whether this commitment is little more than mere virtue-signaling or a genuine commitment remains to be seen. But regardless of motivation, it’s clear that companies are paying attention to the demands of their investor base.
The parabolic rise in ESG investing has met regulatory resistance from the Trump Administration by way of the US Department of Labor (DOL). In June, the DOL proposed a new rule stating plan fiduciaries may not invest in ESG vehicles if the strategy subordinates returns or increases risk for the purpose of “non-financial objectives.” The proposed rule, combined with recent enforcement activity, suggests there’s skepticism and hostility inside the administration and DOL regarding ERISA plan investments in ESG funds. Notably, there were nearly 1,500 comments provided to the DOL during its uncharacteristically short 30-day comment period. Comments on the proposed rule – which came from a wide variety of asset managers, pension funds, investor groups, and others – were overwhelmingly negative and opposed to the rule.
What’s next for ESG?
With such powerful momentum fueling the growth of ESG investing, there are several developments that advisors and investors should consider. Among those are the following:
ESG investing will go mainstream over the next few years. It will no longer be a niche investment strategy. There’s no ignoring the market; billions of dollars of new AUM flowing into ESG solutions will continue to influence firms’ capital-deployment considerations and put pressure on boards to bend to the demands of investors. This trend will only accelerate as more women and millennials join – and eventually overtake – the ranks of investors. Increased market demand will result in more product choices and lower fees. Further, pressure is growing on fund complexes to improve their ESG practices across their entire product line, not just ESG-specific products. Consider BlackRock, the world’s largest asset manager. In Larry Fink’s 2020 letter to CEOs, he put sustainability at the center of BlackRock’s approach to investing. The DOL will cave to pressure from investors and asset managers. Pay attention to not only market demand for ESG solutions, but also to how that demand is pressuring their supply chains and regulatory bodies.
ESG reporting will become more standardized, transparent and widespread. Investors will push companies to quantify and publicize their ESG metrics. In turn, companies will lobby regulators and industry associations to ensure they’re fairly and transparently evaluated using an established rules-based framework to ensure they’re not unfairly or arbitrarily penalized by investors. Look for the emergence of a Morningstar “star-like” ranking system (there are several emergent systems already) or perhaps even a more expansive GIPS- or U.S. GAAP-like reporting system. Such a reporting framework will be critical for investors to better compare ESG approaches and solutions to one another.
Finally, technology will empower investors of all stripes to disintermediate funds and ETFs. The biggest challenge investors face today with funds and ETFs is their inability to customize those products to accommodate the unique needs, tastes and preferences of individual investors. Index-replication technology solves this problem by empowering advisors and investors to build fully customized portfolios of individual securities. Index-replication technology is especially attractive to ESG investors since it empowers them to easily and efficiently build portfolios of individual securities that are custom-tailored to clients’ unique ESG preferences.
The major takeaway for advisors isn’t that change is coming; it’s already here. The key takeaway is that the rate of change will accelerate. It will influence investor demand. It will evolve the products and solutions we use to manage portfolios. And it will ultimately usher in new reporting frameworks and asset management technology that advisors will need to incorporate into their practices to remain relevant.
Donald Calcagni is chief investment officer of Mercer Advisors. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. Past performance may not be indicative of future results.
1 Data from Investment Company Institute and Morningstar, Inc.
2 Hale, Jon. “Sustainable Funds Continue to Rake in Assets During Second Quarter”, Morningstar, Inc., July 30, 2020.
Read more articles by Donald Calcagni