October 27, 2022

What Consultants Tell Clients About Navigating Treacherous ESG Shoals

Asset allocators and managers need guidance at a time sustainability has become a hot political topic.

Reported by Larry Light

Art by Klaas Verplancke

A political backlash against sustainability-oriented investing is building. What do consultants tell their allocator and asset manager clients about dealing with this problem?

If there’s a consultants’ consensus, it’s that they should focus on exactly what a client seeks to do, instead of engaging in broad rhetoric about politics. Clients “may have different levels of [environmental, social and governance] impact” on their investing goals, says Max Messervy, Mercer’s head of sustainable investment, Americas. “You want to see how it applies to their portfolios.”

Given politics’ increasing entanglement with ESG, such a reasonable approach has become difficult. To its detractors, mainly politicians in red states, investing according to ESG means sacrificing returns to conform to wifty, left-wing fashion.

The Missouri State Employees’ Retirement System just sold all its stock, worth $500 million, that BlackRock manages, accusing the world’s largest asset manager of “advancing a woke political agenda.” MOSERS objected to BlackRock’s backing proxy votes that the plan said aligned with ESG objectives. Critics in states that are fossil-fuel producers, such as Texas and Louisiana, complain that ESG threatens their economies.

When the trustees of the Florida State Board of Administration, led by GOP Gov. Ron DeSantis, voted in August to bar the SBA from ESG investing, it declared that applying climate and racial sensitivity to asset allocation would ipso facto mean inferior financial performance. That bald statement is contradicted by evidence that ESG at least doesn’t harm returns.

With that in mind, the best approach is to explore with clients what constitutes their fiduciary duty, consultants say. Although the odds are slender of convincing partisan hardliners to change their minds about ESG, clients in the middle on the subject tend to be more open, by the consultants’ reckoning.

“You have to extend the lens and talk about specific risks,” says Mercer’s Messervy. “Lots of different factors affect performance.” For instance, he says, “what if a company has a pollution problem? That will hurt the stock.”

The ultimate long-term goals of clients are key, in the eyes of Nimisha Srivastava, head of investments in North America for WTM. “What are the risks for clients? You need to integrate them into portfolios.” She notes that critics don’t mention the “G” part of the acronym. “Not having good governance is a risk” in a company whose stock a client might want to buy, she explains.

“Be specific about what green means—you can’t be vague,” says Dan Mistler, a partner in ACA Group. “What’s needed is a lot of discussion, and discussion that’s not ideological.”

And if, say, a pension plan remains unconvinced, then “go to another provider” that would make the program happier, Mistler says. That’s apparently what’s happening with BlackRock, even though the company contends that it isn’t pro-ESG, but offers a range of investment strategies tailored to all beliefs, whether pro- or anti-sustainability. (The states that have BlackRock had just a tiny fraction of its vast assets under management.)

Consulting when ESG is part of the equation is not easy. Consider Meketa Investment Group, which last year joined an association called the Net Zero Investment Consultants Initiative, dedicated to giving advice to clients on limiting global warming. In September, though, Meketa announced it was temporarily withdrawing from the alliance and “will seek to adopt NZICI’s global reporting framework at a more appropriate time.”

While Meketa didn’t give reason for its departure, a report by the Capital Monitor, a sustainable investing news service, says that the firm felt some U.S. clients “were not ready for that discussion.” So, in other words, it looks as if these clients were resisting climate-minded advice.

Among consultants, the hope is that the ESG dispute will fade with time, and sustainability will become an accepted piece of financial strategy, much as it already is in Europe. ESG “is new now, it’s an ideal,” says WTW’s Srivastava. “In five to 10 years, this won’t be controversial.”