The US wealth advisor wants standardized ESG reporting but says it's a few years off; and, deluged with ratings information, asset managers ultimately have to use their own judgement about which impact metrics are the most additive.

US assets under management using ESG criteria stood at $12 trillion at the beginning of 2018, a 38 per cent rise in two years, and the equivalent of 1 in 4 dollars of the $46.6 trillion total managed in the US. By value, the US market is second only to Europe for socially responsiblie investing. Unearthing the explosive growth and how some of those dollars are being invested and reported, Family Wealth Report spoke to Tiedemann Advisors. The firm has around $18 billion under advisement and has been embedded in impact investing and associated approaches in the US market for more than a decade. With impact investing at the more stringent end of the ESG spectrum, and capital flooding in, there is concern about scaling with integrity. "While it’s a growing market, we’re still seeing demand from high net worth families and institutional investors like foundations, endowments, and non-profits outpacing the supply of high-quality, institutional impact investments," said Tiedemann's managing director and environmentalist, Brad Harrison.

How far advanced is the wealth management industry in embracing ESG? Are we at the early stages still or are there already signs that it is maturing and becoming “mainstream”?
Harrison: Impact investing has absolutely become mainstream. Most large banks, brokerage houses, and (strategic) investment advisory firms have or are building an impact offering for their clients. To give you a sense of the global scale we’ve reached, in April 2019, the Global Impact Investing Network (GIIN) published a report sizing the impact investment marketplace and identified over 1,340 organizations managing $502 billion (£385 billion) of “impact assets” worldwide.

Domestically, the US Sustainable Investment Forum (US SIF) has deemed $12 trillion of the $46.6 trillion of professionally managed assets in the US as “socially responsible”. As the market expands, we (and others) need to be sure that those making impact investments remain committed to the core characteristics of impact investing - and the market achieves “scale with integrity.”

As a follow-on from this, at what point can managers know whether they have reached full capacity of how much money can be deployed without pushing up valuations and creating the temptation for so-called mission drift? How scalable is ESG investing? There is lots of demand for ESG – is there enough on the supply side?
While it’s a growing market, we’re still seeing demand from high net worth families and institutional investors like foundations, endowments, and non-profits outpacing the supply of high-quality, institutional impact investments. Mission drift is always a concern, yet we’re seeing an increase in structures where fees and performance are tied to the impact outcomes, further aligning incentives with the impact the investor is seeking.

Within impact investing, what options are typically available for clients? Are there standardized types or is it still bespoke?
Impact investing typically falls into three categories in client portfolios. (1) Values aligned investments – these strategies screen out companies or sectors that conflict with an investors’ personal values. (2) ESG integrated investments – these strategies incorporate environmental, social, and governance “ESG” factors into the investment process, often as a risk management tool. (3) Thematic/place-based investments – these strategies support a specific theme (eg, education) or geography (eg, Detroit).

Over the years, we’ve noticed what may seem like a contradictory trend: both more standardization across the above approaches and an increased amount of customization within them. We have a more standard understanding of how to approach impact investing, yet the way in which these strategies are implemented continues to diversify.

What’s your assessment of the state of ESG reporting to clients today? Is it still primitive or getting more advanced? Does it convey information that’s clear and engaging? Can the data show if the investment manager is adhering to stated principles or deviating from a particular benchmark?
Tiedemann’s ultimate goal is to provide standardized ESG reporting just as we provide standardized financial reporting. This is still a few years off, but we do see light at the end of the tunnel. This is the first year where we are effectively running both financial reporting and impact reporting off the same reporting platform for our clients. Several industry-wide initiatives to standardize ESG data are showing real promise and practical application, including the Sustainable Accounting Standards Board (SASB), the work of the Impact Management Project, B-Analytics, and others.

Quite a few ESG investment strategies seem to fall into two camps: qualitative, requiring the manager to use his/her judgement, and quantitative, where certain metrics and data points are followed. Do you see a trend favoring one or more of such approaches?
Definitely quantitative, and the good news is that the volume of ESG data is growing exponentially and continues to improve. Consider that in 2007, Bloomberg, one of the largest data providers in the financial industry, provided almost no ESG data. Today, Bloomberg aggregates hundreds of ESG-related metrics.

While this is good news, it comes with a catch. Unlike financial data, ESG data is neither standardized nor mandatory. This results in selective reporting, uneven coverage, and hundreds of industry or company specific metrics. In our experience, the most successful asset managers use their own judgment to navigate the deluge of information and apply the impact metrics that are most additive and integral to their investment decision making. After all, the most effective investments are those where the financial and non-financial outcomes are inextricably linked.

Is there a risk that a lot of ESG investing will be heavily biased towards listed equities because these markets are public, have high levels of disclosure, and that investors could risk being underweight on bonds, private capital markets, real estate, etc? What can be done to address this?
No, we don’t see this as a risk. We think Responsible Investing/ ESG/ and Impact Investing can be approached with the same asset allocation and portfolio construction philosophy as is used in traditional portfolio management. Oftentimes we see impact investors discount public markets as a lever to promote meaningful, widespread societal change in favor of some of the “sexier” asset classes like private equity, venture capital, and real estate. Case in point, the Securities and Exchange Commission recently required publicly traded companies to start disclosing the relationship between CEO compensation and that of the median employee. This has the opportunity to affect far more people and address a real income inequity gap, and an outcome of public discourse, ESG investment, and shareholder engagement within listed equities.

Are there regions of the world most suited to ESG investing or which exhibit particular attractions for ESG investors?
We believe that ESG investing has a place regardless of geography. That said, how ESG investing is practised can change depending on the region. For example, ESG metrics are more widely available in developed markets, like the US and Europe. As a result, it is easier for ESG managers to identify companies with strong ESG characteristics. In contrast, ESG data is less widely available in developing markets. As a result, ESG managers tend to rely on direct engagement with company management to understand corporate practices on ESG issues.

How should a manager go about framing client expectations about the monetary returns that ESG investing makes possible? Have we got beyond the idea that there’s any sort of trade-off between ESG and making lots of money?
We’re not past it, and we actually think it’s a good debate. We adhere to our belief that ESG/impact investing can be implemented without sacrificing risk-adjusted returns (we’ve proven this). Case closed? Not exactly – because we also acknowledge that some clients actually do want to sacrifice investment returns in exchange for outsized impact. How is this done? Instead of maximizing for a particular social, environmental, or financial return, we see value in optimizing for all three, and this may mean intentionally taking a “trade-off” – but a calculated one.

What is your firm doing to train and educate staff about ESG to incorporate these ideas into how they talk to clients, analyze investments and manage portfolios? Are there talent shortages and skill gaps and how are you trying to deal with these?
We are integrating ESG and impact investing principles across the firm, at all levels. Contrast this with many banks, brokerage houses, and investment advisory firms who employ a dedicated team of “ESG specialists” who work in isolation from the rest of the core business. To integrate, and continue to stay at the forefront of this rapidly changing field, we host national retreats, regional trainings, attend conferences, meet regularly with investment managers, engage directly with our long-standing impact clients, etc.

We’ve also created an Impact Advisory Council made up of national experts in impact investing, like Jed Emerson and Richard Woo, to ensure we achieve that “scale with integrity” we discussed earlier. Another example is that the president of our firm, Craig Smith, serves as chair to our Diversity, Equity, and Inclusion Committee to ensure that our investment priorities mirror our internal operations.