ESG Investing: Driven by Risk Management & Client Demand (Part 2)

Posted: October 27, 2020

Board room conference table

There’s been a paradigm shift in our recent conversations with financial advisors about ESG investing.

Whereas ESG investors previously were thought by some to be anti-capitalist tree huggers, this silly trope has run its course. Instead, there is a realization that optimal management of resources, social equity, and ethical corporate administration can significantly benefit human productivity and profits across the board.

This realization has helped portfolio managers recalibrate the idea of risk that is embedded within a portfolio. Just the same, the groundswell that is ESG has made it increasingly self-evident to investors that they no longer have to choose between their ideals and returns.

Exploring ESG Concepts

We aim to explore concepts around ESG investing in this briefing, which is the second in our three-part series:

  1. Early obstacles and an entry point
  2. Drivers and barriers (the focus of this post)
  3. Implementation within portfolios

Our framework takes cues from a whitepaper published by the CFA Institute, “ESG Integration in the Americas: Markets, Practices, and Data. ” Their main findings (in bold below) are a suitable framework for us to opine on the topic, though we have rearranged the findings to create a more sensible narrative for these purposes.


The main drivers of ESG integration are risk management and client demand.

ESG investing is based on the idea that a company’s future profitability is based on its corporate sustainability, as measured by environmental (E), social (S), and governance (G) factors.

E, S, and G? That’s a lot of ground to cover: from greenhouse emissions to business ethics, privacy/data security to board independence/diversity, and plenty in between.

Many money managers who have applied ESG factors as part of their risk management discipline have started with the low-hanging fruit, by honing in on the governance aspect. It makes sense. It’s the easiest of the three to assess repeatedly. And the impact of governance standards are usually more visible and recurring than environmental and social factors, which occur more episodically, such as a significant workplace accident.

The expansion to incorporate more of the E and the S factors has usually been with the goal of obtaining a more comprehensive view of a company in order to protect and enhance the economic value of an investment.

While portfolio managers are recalibrating, investors also are embracing the opportunity to align their financial futures with their personal values. And they’re putting their dollars where their mouths are.
Starting in Q1’19, flows into sustainable funds in the U.S. grew materially, with that quarter recording more than double the inflows as 1Q’18. Another more-than-doubling occurred when you compare 1Q’19 and 1Q’20.

Here’s the kicker: The U.S. is actually quite the laggard in terms of ESG investing when compared to Europe, which is the largest market for sustainable investing. Europe accounts for more than 75% of global sustainable assets.

In short, it leaves a lot of runway here in the U.S.

Barrier 1: Data

The main barriers to ESG integration are a limited understanding of ESG issues and a lack of comparable ESG data.

We believe the understanding of ESG issues is a bigger challenge in the near term than the lack of comparable data. This is not to say that data enhancements and reporting standards do not need to be improved. They do. As the CFA Institute’s white paper states, “Investors justifiably remain concerned with the quality, accuracy, and comparability of the ESG data they are using in their analyses.”

However, there are levels of subjectivity and abstraction that investors must be willing to accept with ESG factors. And as my fellow Co-Founder Jon Robinson pointed out in the first briefing in this series, even with more commonly accepted definitions like “value,” there’s still room for interpretation when it comes to portfolio implementation. Still, the comparison of data will grow increasingly easier, as I will detail in the next section.

Getting back to understanding of ESG issues, we think political discourse has hijacked the narrative around ESG investing. This has slowed acceptance of ESG principles as being consistent with a business environment that promotes freedom and prosperity. To be clear, just as Friedrich Hayek believed that preserving health and the capacity to work was essential to free market economics, Blueprint Investment Partners believes that investing in companies that are aligned with this notion will grow increasingly ubiquitous in a less divisive political environment.

Barrier 2

It would be helpful for issuers and investors to agree upon a single ESG reporting standard that could streamline the data collection process and produce more quality data.

Our philosophy around ESG investing is that it is a way for investors to maximize returns consistent with expressing their values within their portfolio. There is a lack of specificity, however, with the extent to which one may express their views due to the lack of standardization in the data from one investment strategy to the next.

Standardization, which you will recall from your statistics courses in college, requires putting different variables on the same scale. To ensure success, we think this is best left for an objective third party, like the CFA Institute, the United Nations-supported Principles of Responsible Investment, or the World Economic Forum.

We are also closely monitoring the recent developments at the fourth annual Sustainable Development Impact Summit, where it was announced that the Big Four accounting firms have developed a set of metrics for companies to use for environmental, social, and governance reporting internationally. This could not only address the standardization issue, but also help investors avoid marketing gimmicks that attest to ESG superiority.

Not Having ESG Conversations With Clients Yet? Get Ready.

We think the recalibration of risk from a portfolio management perspective and demand from investors will only grow more robust in the years ahead.

In fact, I believe we will eventually look back on Larry Fink’s advocacy of ESG investing much in the same way we look at Jack Bogle’s advocacy for index funds, albeit Larry’s contribution has much broader implications.

Between now and then, we think there’s an opportunity for financial advisors to differentiate themselves with ESG. Rather than react and respond to clients who raise questions about, “that ESG thing,” advisors can seize an opportunity to proactively raise the topic with clients and provide guidance about investment options that allow investors to align their long-term investment goals with their personal values.

We welcome the opportunity to help you prepare by discussing the Blueprint U.S. ESG Strategy. Please reach out with any questions.

Lastly, I hope you’ll keep an eye out for the third and final installment of our ESG series, in which we will examine the implementation of ESG factors in portfolios.

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