Can wealth managers adapt to an increasingly ESG-sensitive investor?

Investors increasingly want to feel more involved in how their money is channeled into sustainable investments, and companies will need to respond to this in the not-too-distant future, says Jonathan Wauton, co-founder [and chief commercial officer] from Tiller Technologies.

The growing sophistication of ESG investors is a threat that wealth managers cannot ignore.

Few, if any, investment trends have truly galvanized an entire generation of investors the way ESG (environmental, social and governance) investing has.

Portfolio managers are used to being in a position of power when it comes to investment knowledge, but the massive adoption of sustainable or ethical investing by their investors means that they will, over time, erode that lack of knowledge.

Not only do investors know they want ESG-friendly investments in their portfolio, they are also beginning to specify the type of ESG holdings they want, identify leading managers in the field, and whether they want a active or passive exposure.

This means that wealth managers may find it increasingly inappropriate for their clients to be invested in their standardized model portfolios.

Adopt specialization

There is already a wide range of model portfolios seeking to meet a wide variety of investor demands for ESG investing. But the complexity of the trend and the increasingly tailor-made desires of investors mean that specialization will be increasingly sought after.

For example, different clients will have different views on how aggressively they want their portfolio to pursue net zero goals, or to focus on broader social issues or governance issues. They may also differ in terms of the “impact” they want their portfolio to have; it’s about balancing their desire for their portfolio to provide a financial return versus a social or environmental benefit.

Model portfolios can go no further here, which means wealth managers need to consider ways to create and monitor bespoke portfolios that can truly meet their clients’ sustainability goals.

One way to achieve this could be to rethink the core/satellite approach for portfolios, making it relevant for the ESG era.

A clear strategy

Classically, wealth managers may have taken an approach that places the majority of a client’s cash in more traditional assets (judged on the basis of performance, independent of ESG or non-ESG), then added small pots around this “core” to allow exposure to riskier or more specialized sectors.

This strategy could be developed for use in offering bespoke ESG portfolios, where the core offers exposure to broad climate and ESG-related investments and the so-called “satellites” target impact requirements more customer-specific, for example.

The beauty of this approach is that the core can also have a slant, if the client so chooses, allowing them to really direct their investments towards the issues and causes they are most passionate about.

Data and efficiency challenges

Wealth managers can theoretically agree that this broad option would be attractive to clients.

But they may have reservations when it comes to considering how a company could competently manage a myriad of different portfolios in a way that suits the client, satisfies regulators and is efficient. For some, this may feel like a return to personally managed wallets, with all the associated problems, which the rise of the model wallet service was meant to replace.

The problem with choice and flexibility lies in its effects on other factors, including volatility and tracking error.

Narrowing your investment universe, which tends to happen the more specialized a theme becomes, often means more concentrated risk. It also often involves moving away from a broad underlying market capitalization index, against which the portfolio can be benchmarked.

Technological solutions

Luckily, advances in technology are here to help. It is now possible, through the use of specifically developed tools, to create a system where clients can have the portfolio they want, in a systematic process, which can be easily managed and overseen by wealth managers.

Portfolio managers can choose investments from their current buy lists with pre-assigned ESG scores, to enable them to build tailored portfolios for clients of any shade of “green”, while being sensitive to the risk and return desires of the client.

In this way, technology can be seen as a way for businesses to provide their customers with new products in new ways, rather than just the same product, more efficiently.

Fundamentally, such technology enables wealth managers to provide unbiased and transparent data on the ethical or sustainable character of their underlying investments.

Such insight could prove vital when a company is asked by its increasingly savvy clients about the effectiveness of their portfolio, or even worse, a regulator eager to find ESG investments that just talk.

Dolores W. Simon