The rise of ESG Investing

I met a financial advisor for a coffee a few weeks ago. He wanted to pick my brains about ethical investing. He said he wanted to be 'more green' and wanted my advice on building ethical portfolios for clients. He seemed to think ethical investing was merely about avoiding tobacco and arms; it's moved on a lot, I said, as I rolled my eyes, questioning whether he was willing to be truly committed and informed about the world of ethical investing. I came across this great piece of investment research by Calvert Research and Management called 'The Rise of ESG Investing' which talks about the latest trends and client drivers. It also talks about financial advisors and their attitudes towards ESG. The study is US based. However, I think it translates well to the UK market too. I marked out some interesting bits and listed them below with my comments.

On Millenials

Born between 1980 and 2000, Millenials command wealth, a social conscience and power. By 2020, it is estimated they will make up 46% of the workforce. This is a generation with sway and swag, who hold social responsibility, social justice, equality and environment causes as top priorities.

Research quoted in the report states that 53% of millennials make investment decisions based on social responsibility factors, compared to 42% of Gen Xers, 41% of baby boomers and 39% of seniors. I don't see too many millennials in my advisory practise and I really enjoy seeing them when I do; but it is encouraging to see the younger generations voicing themselves so clearly.

ESG Takeaways

Advisers should incorporate basic ESG questions and filters into their initial discussions of goals and objectives with current and prospective clients and take a proactive approach to identifying needs and interests. 

I strongly agree. I don't push ESG investments as a 'right' or 'preferred' way of investing; it is not for everyone, and yet, the client has a right to make an informed decision - ESG or not. I imagine advisors enjoy offering a broader menu of options to clients and those who have worked hard to acquire expertise & conviction in ESG investing reap the benefits in attracting investors interested in responsible investing.

For many advisers, portfolio performance is a non-issue when it comes to ESG considerations. It ranks near the bottom of the reasons advisers utilize it; for non-users, ESG's limiting of investment options ranks near the top of considerations. Just 29% of advisers believe there is a positive correlation between corporate financial performance and ESG factors. While manager selection for ESG strategies may be limited compared to the broader universe of funds and managers, the menu is increasing in size. Overall, investment research broadly suggests that the performance of socially conscious funds has a "positive tilt relative to the overall universe of funds". While returns may not be a real hurdle, there is an increasing breadth of options - and potential strategies - that advisers can utilize.

Returns aren't a hurdle. True.

There are around 113 funds that meet the ESG/Ethical criteria as regulated funds for clients in the UK so yes, the universe is smaller. Also, the menu of available investment options excludes passive funds (there are a few, but they don't meet enough criteria to be included in any meaningful way) which means clients may pay a bit more for an ethical portfolio which necessarily includes actively managed funds and consequently higher fees than passive funds. However, more and more, I see a greater abundance of options including with company pensions, such as the L&G Future World fund focused on climate change, which is encouraging.

Adviser usage of ESG factors

The strongest indicator of adviser utilization of ESG factors was the level of client interest in social and environmental issues and, secondarily, the adviser's own knowledge of responsible investing as well as their performance of the importance of evaluating ESG factors for client portfolios.

I have met clients who are keen to invest ethically but then are put off by an adviser's own biases; I believe this is more to do with the advisers own level of felt competence in the area than the facts of whether ESG is an inferior strategy as an investment option or not. 56% of advisors cite client demand as the main reason to utilize ESG. Among advisors who don't use ESG investments, 58% said their clients are not interested in ESG factors, 29% said it leads to limited investment opportunities and 22% said it leads to poor or limited returns; I hear that last one most often too when I talk about it informally with advisor colleagues.

ESG factors brought up most often in client meetings

Among all ESG factors, the "E" - environmental - draws the most client interest. In our survey, 39% of advisers said that clean technology was one of the most commonly prioritised ESG criteria in client meetings, followed by climate change (35%) and emissions and waste (26%). 

An ethical investment questionnaire now has so many factors to it including pornography, human rights violations, genetic modifications, product stewardship and animal welfare.  It has definitely moved on from a simplistic negative screen of avoiding tobacco and arms companies. The survey also lists under social and governance issues the factors most frequently mentioned were human rights (22%) and corporate transparency (16%).

Knowledge stands in the way

Just 38% of responding advisers in our survey answered "Yes" to our question, "Do you feel knowledgeable when it comes to ESG investing?" Aside from client demand, advisers cite moral/ethical reasons as the secondary driver for their use of ESG.

38% is quite a large number. So, for clients who are looking to invest ethically or with ESG in mind, going to a knowledgeable advisor on ESG makes sense.

Further resources:

Ethical investing: Positive and negative screening criteria

Three myths about Ethical Investing

Sustainable tourism: A week in Morocco

Growing a Culture of Social Impact Investing in the UK

My Favourite Books I read in 2017

My intention for 2018 is to read every day, meditate every day, cut back on social media time and be more like Cal Newport who inspires me with his writings on 'deep work'. January is a digital detox month and my brain already feels so much clearer. I cheated a little bit though and have sent the odd tweet. For the most part, though, I have been 'good' and spent more time offline with friends and on the phone. I digress. Back to my favourite books listed below. Oh, I only read non-fiction - so there’s no lists for fiction if that is your thing.

Non-Fiction

Your Money or Your Life by Joe Dominguez,‎ Vicki Robin, Monique Tilford and Mark Zaifman

A very sneaky book...in the sense, that it is non-prescriptive and yet, it gets you to follow some basic steps such as methodologically tracking all your income & expenses, which ultimately leads you to reflect, introspect, get clear and make different decisions with both earning, spending and using money. You start seeing money as an exchange of life energy and have a logical way of seeing this- see my post - Frugal is Freedom for more on it. Also, if you are interested in FIRE (Financial Independence, Retire Early), this is a good book to read.

Misbehaving: The Making of Behavioural Economics by Richard Thaler

If you had any illusions about how rational we humans are with money, this book sets you straight. Interesting research, great anecdotes and useful to learn the psychology behind money decisions.

Finance for Normal People: How Investors and Markets Behave by Meir Statman

Having heard Meir Statman speak on podcasts, I grabbed this book as I found his insights worthwhile. He talks about the emotional, expressive and utilitarian uses for money. We compartmentalize money into buckets, have incredibly foolish behaviour with it, take mental shortcuts, are overconfident investors and so much more. Meir helps investors reflect on what they really want from their investments focussing on what is the money for  - retirement, children's education, socially responsible investing and so on. He also advocates automating investments. Overall, a worthwhile read and useful especially if you invest and want to understand yourself as an investor better.

Non-Investment related

The Nonviolent Life by John Dear

What is a nonviolent life and how can we be nonviolent to ourselves, others and join a global movement to impact the world? John Dear, a Nobel Peace Prize nominee attempts to answer this question and does so beautifully. Bear in mind, he is a Christian and so teachings of Jesus (whose message of nonviolence was radical for his time- love your enemy, what?) are sprinkled liberally through the book which I actually enjoyed. I bought the book for myself and gifted it to a few friends.

Sapiens: A Brief History of Humankind by Yuval Harari

First of all, Yuval Harri practices Vipassana, also known as Insight Meditation and does 60-day silent retreats; he plans his working year around that and schedules it first. For this, I already hugely admire him. Secondly, I find history very dull and could never get into it in college or school. However, this book - I could not put down. I also like that he weaves relevant connection to our present day issues whether it be talking about colonialism, racism or money stories; worth buying and savouring every page. There is no thirdly.

The New Jim Crow by Michelle Alexander

I heard about this book via Miki Kashtan, an international Nonviolent Communication teacher whom I deeply admire and trust. The book made me quite angry & disgusted. No, the book didn't do that, I chose to. I felt quite angry on reading the book and yet, I was glad to have read it - we need to be better educated about crime and 'justice'.  The book shines a light on racial segregation, colour blindness, how the prison system in America almost substitutes slavery. It is very thought-provoking and well worth the emotional aggravation you may feel on reading it.

A Guide to the Good Life: The Ancient Art of Stoic Joy by William Irvine

A great manual for life, if you are interested in Stoicism, then even better. It talks about reducing worry and focusing only on things we can actually control (not very much). I love the challenge of letting go of the 'illusion' of control we have and learning a philosophy that helps you have a truly joyful life. I became interested in Stoicism through the work of Tim Ferris and so glad I bought this book, highly recommend.

Evicted: Poverty and Profit in the American City by Matthew Desmond

Winner of the 2017 Pulitzer prize for non-fiction, it is an incredible read. Matthew Desmond is an ethnographer, he lives in communities in the United States that struggle with housing and tells an honest, heart-breaking account of incredible characters who struggle to keep a roof over their head. The struggle with homelessness is so real, the landlords have a lot of power with eviction and it seems the system almost obstructs survival for tenants who fall behind. Residential stability is important for psychological stability and community stability. Families lose so much with eviction. I read recently that this book also made it to Barack Obama's recommended book list for 2017.

Further reading:

My favourite books on Money and Personal Finance

Loss aversion bias and checking your portfolio

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How often should you be checking your investment portfolio? Does it matter? From the viewpoint of behavioural biases, there is evidence that experiencing losses leads to poor choices. Loss aversion - our intense dislike of losses can cause us to lose even more if we pay attention to our portfolio losing money. It hasn’t been an issue in the last eight years of a rising equity market and yet, being willing to accept a drawdown or loss is an integral part of managing behaviours needed to be a successful investor.

In the book, The Smarter Screen by Economist Shlomo Benartzi with Jonah Lehrer, an experiment helps shed more light on this:

In one lab experiment by Richard Thaler, Amos Tversky, Daniel Kahneman and Alan Schwartz, subjects were more likely to invest in a bond fund when feedback was given more frequently. Unfortunately, these low-risk bonds also generated lower returns over the long haul. As the scientists noted, “ Providing such investors with frequent feedback about their outcomes is likely to encourage their worst tendencies...More is not always better. The subjects with the most data did the worst in terms of money earned.

Ten years ago, most clients got paper valuations twice a year and so, tended to look at their portfolio valuations twice a year. We now have access to information everywhere, thanks to our magical devices.

The abundance of feedback is not necessarily a good thing especially with medium to long-term horizons in mind- such as a retirement plan twenty years away. Being willing to ‘do nothing’ or hold bonds or investments that may temporarily lose value is necessary for being a successful investor - to avoid impulsive decisions and following the herd.  

Investing is simple, but not easy. Being self-aware and getting to know your own behavioural biases is useful if you want to hold onto your wealth from investing.

Further resources:

 

Book Review: Simple Wealth, Inevitable Wealth

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“The mortal enemy of investment success is fear.” - Nick Murray I was fortunate enough to buy Nick Murray’s book The Excellent Investment Advisor early on in my advisory career. It made complete sense to me, stressing the role of an investment adviser as behavioural coach. I recently heard about Simple Wealth, Inevitable Wealth on a podcast with a US-based financial adviser, I bought it - a 1999 copy set me back about £25 and it is worth it!

Some of my favourite lines from the book are below with my thoughts:

“”Wealth isn’t primarily determined by investment performance, but by investor behavior.””

Numerous conversations with clients have convinced me that we have our unique perspectives and biases around investing which influence our decisions. A great investment portfolio needs to have global diversification, asset allocation, low costs, etc. Given a well-constructed portfolio, clients who have the ability to stay detached and take the long-term perspective with patience and discipline can usually achieve greater financial success.

On picking a financial adviser:

“Do not care what they know until you know that they care.”

Since you are trusting your financial adviser with your wealth and your family’s wealth, technical capabilities and competence can only take you so far. Trusting in your adviser’s judgment is important and so take your time looking for someone you can really trust.

On Risk:

  • “People greatly overestimate the long-term risk of owning stocks. People seriously underestimate the long-term risk of not owning stocks.”
  • “The great long-term financial risk isn’t loss of principal but erosion of purchasing power.”
  • “The real long-term risk of equities is not owning them.”

Here, he means stocks as an asset class. Important to remember you only invest in stocks if you can stay invested for 5 years or more. If you haven’t ever invested in equity, that would be quite risky behaviour, according to him.

On Investor behaviour:

“The single most important variable in the quest for investment success is also the only variable you ultimately control: your own behavior.”

I have to agree and love that this is within our control. You can’t control the markets, economic forces of nature or will things to go your way. You can choose how you react to all of it.

On the active/passive debate:

“At the end of the day, it isn’t indexing v/s active management. It’s cost.”

The cost of your portfolio has a direct effect on the growth of your portfolio - an important factor in portfolio construction.

Really enjoyed reading this book & highly recommend!

Are pensions better than ISAs?

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Pension vs ISA

If you are saving for retirement and looking for better options than a pension, including comparing to ISAs, I simply haven't found one. As long as you can afford to invest your money, knowing it isn't accessible until 55 (or whenever the scheme rules say), pensions are undeniably the most tax efficient way to invest for your retirement.

A pension is simply a tax-advantaged investment wrapper. It's tax advantages are significant; the money you pay in is topped up by tax-relief. Moreover, the idea is to put money away where it cannot be easily accessed. So, the fact that it isn't accessible. I don't see it as a disadvantage.

Did I hear you say buy- to- let's are your plan for retirement? Please read my blog 'Dark clouds over buy-to-let investments' if you are open to a gentle challenge.

Not understanding how pensions work could hurt you financially. Here is an honest, genuine account from Jason Zweig, author of 'Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich', a book worth adding to the 'Money' section of your library.

In 1993, the mutual fund editor at Forbes magazine was contributing 5% of his salary, just half the allowable maximum, to his 401(k). When a friend asked why he didn’t put more into his 401(k), the editor shot back, “Because I can do better with my money than they can, that’s why.” Looking back more than a decade later, the former editor calculated how much this decision had cost him. I know the answer, because I was that editor. The cost of my overconfidence is more than a quarter of a million dollars- so far.

Tax Treatment (Are pensions better than ISAs?)

One area where pensions and ISAs differ is on the tax breaks given to individuals when payments are made, and when funds are accessed.

Pension:

  • Money In: Pensions enjoy tax relief on contributions. For DC schemes, savers will typically pay in an amount net of basic rate tax, with the provider adding basic rate tax to the fund*. Any higher or additional relief is claimed through self-assessment. So a £10,000 pension contribution will require a payment of £8,000. A higher rate taxpayer would be able to claim a further £2,000 tax relief via their tax return, and this will reduce the tax they pay on their other income. So the net cost to an investor paying higher rate tax is £6,000. *Some occupational schemes will collect the gross employee contribution from total pay before tax is collected under PAYE. Employees will get tax relief at their highest marginal rates immediately and do not need to make any claims through self-assessment.

  • Money Out: Up to 25% of the pension fund can be taken completely tax-free. The balance is taxed at the saver’s highest marginal rate of income tax.

ISA:

  • Money In: There’s no tax relief for payments into an ISA.

  • Money Out: All withdrawals from an ISA remain tax-free.

Source: Standard Life: Spotlight on Pension v/s ISA Other related resources: