unlearning the alphabet.

By Bill Davis

Values-based investing has been around for hundreds of years and long before the terminology surrounding this practice got confused by labels such as socially-responsible investing (SRI) and environmental, social, governance investing (ESG). At its core the idea is a good one: use capital to support ethical preferences of investors whether these be based on faith, worker-rights, the environment, or something else entirely. The challenge has always been to do so without under-performing the market in the process, and historically speaking, practitioners often failed to generate competitive financial returns. As a result, financial advisors just as often advised against values-based investing and the overall movement struggled to become mainstream.

To put a finer point on this: under-performance led to mis-alignment with advisors, which led to capped interest, which stagnated the industry. It’s that simple.

But as the saying goes, that was then and this is now. Environmental damage, poor governance, and geo-political risks, to name a few, are also portfolio risks, just not ones captured by traditional approaches to portfolio construction. Companies that aren’t good stewards of the environment, the communities within which they operate, and their employees are a threat to portfolio returns. And since more and more companies file annual corporate sustainability reports that detail their progress toward material ESG risk factors, a new generation of portfolio managers has emerged armed with actionable data and a growing demographic of investors seeking values-based investing.

With proper portfolio construction, portfolio managers can now mitigate off balance sheet risks and at the same time perform at or better than their benchmarks. In other words, practiced properly, values alignment is free. There’s only one problem…just at the very moment that portfolio managers have proven that values-alignment is essentially free, and more and more investors – be they institutions, family offices, individuals, etc, - are actually looking for product in this area, the financial advisor community is mostly stuck in the 20th century, equating values-aligned investing with poor performance.

It stands to reason that many financial advisors have the same concerns as their clients as it relates to the world their children and grandchildren will inherit, so on many levels there is complete alignment. So why are financial advisors a roadblock in this movement?  A former work colleague of mine referred to this problem as one of “unlearning the alphabet”. Financial advisors grew up in the age of underperformance, assume nothing has changed, and that has become the lens through which they view the industry. In reality, almost everything has changed except their view of things.

Consider that there are 80 million Millennials that are due to inherit up to $30 trillion of wealth over the next ten years.  And given they care a lot more about social justice and the environment than their parents, financial advisors might consider that in order to retain these clients they will need to start incorporating values-aligned strategies into their portfolios.

So for investors that care about aligning capital with values, start demanding viable product from your advisors; and for financial advisors, it’s time to unlearn the alphabet of the past and catch up to a new way of looking at portfolio risk that will help keep and even attract new clients.