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Globe Investor Why integrating ESG principles into investors’ portfolios makes sense

Integrating material environmental, social and governance factors into securities analysis and selection can help improve both risk-adjusted investment performance and corporate ESG outcomes.

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Canada’s investment landscape has surpassed a major milestone, with more than half of total assets under management now invested in accordance with environmental, social and governance (ESG) principles – and there is no end in sight for this growing trend.

But while the appeal of ESG investing may be one of morality for some investors, integrating material ESG factors into securities analysis and selection can help improve both risk-adjusted investment performance and corporate ESG outcomes. Financial advisors who wish to embrace ESG investing and offer it to their clients need to consider the following three foundational questions:

1. Why do your clients want to invest this way?

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Advisors need to determine their clients’ primary motivation and goals. Do clients want their investments to resonate with their personal values? Are they seeking broadly diversified investment portfolios along with better corporate ESG outcomes? Or both?

Alignment with personal values can be done through a screening process in which particular investments or sectors are either eliminated (for example, those that are carbon-intensive) or emphasized (such as alternative energy). Values-based screening can send a public signal to corporations about changing norms and values, but it’s different from the analytical approach that underpins a traditional investment process. For advisors with clients who fit the values-based profile, it’s important to ensure these investors’ portfolios remain consistent with their values when securities holdings change.

Alternatively, the integration of material ESG factors into the securities analysis and selection process aims to uncover hidden investment risks while subsequent engagement with corporate management nudges companies to improve their performance on relevant ESG issues. Under strict ESG integration, there is no alignment of holdings with particular client values. Rather, this is a broad-based approach that seeks to produce better ESG outcomes among all companies.

Note that the two approaches are not mutually exclusive and that it’s possible to use screening while employing ESG integration on the remaining securities in a portfolio that are not screened.

2. Do you construct clients’ portfolios with investment products or individual securities?

Mutual funds and exchange-traded funds (ETFs) publish the type of screens they employ – and whether they integrate ESG principles or engage with companies – in their prospectuses. Advisors who read products’ prospectuses carefully can match their clients’ goals with the appropriate investment vehicles.

In contrast, advisors who construct portfolios of individual securities may need to seek detailed ESG and sustainability information from third-party sources if their firms’ research teams don’t already provide it. There are several large, established providers of this information in Canada, including Sustainalytics and MSCI Inc., as well as many other smaller providers.

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Ian Robertson, vice-president, director and portfolio manager at Odlum Brown Ltd. in Vancouver.

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Advisors who are also licensed as portfolio managers and whose employers are set up to vote proxies on clients’ behalf may also want to subscribe to a proxy advisory service to ensure the appropriate ESG nudges are sent at corporate annual general meetings.

There are two proxy advisors that dominate globally: Institutional Shareholder Services Inc. and Glass, Lewis & Co. In Canada, there is a smaller firm, Shareholder Association for Research and Education (a.k.a. SHARE), which focuses exclusively on responsible investing.

A second benefit accrues to clients when advisors vote proxies on their behalf: relief from the seasonal tyranny of corporate annual reports cluttering their mailboxes.

3. Will you pursue additional education?

For a comprehensive, global overview of “responsible investment,” advisors should start with the United Nations-backed Principles for Responsible Investment’s (PRI) website.

If you’re interested in more formal education, the PRI has developed courses tailored to both securities-licensed and mutual fund-licensed advisors, which in Canada are delivered through the Responsible Investment Association*. The courses can also lead to designations recognized by the national regulatory agencies (including the Investment Industry Regulatory Organization of Canada), as well as continuing education credits with organizations such as CFA Institute.

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There are also executive education courses of varying lengths offered at several foreign and domestic universities, including a full post-graduate diploma at Concordia University’s John Molson School of Business – the Sustainable Investment Professional Certification.

There are many reasons for advisors to incorporate ESG investing into their practices. Research shows that clients’ input into their investment choices heightens confidence, which can help in volatile markets. That’s a benefit to both clients and advisors from an alignment of values perspective. In addition, nudging corporations to better outcomes through ESG integration should enhance risk-adjusted returns and benefit broader society. In either case, advisors can build an enduring practice while helping their clients toward better outcomes.

*Ian Robertson is vice-president, director and portfolio manager at Odlum Brown Ltd. in Vancouver. He also serves as chair of the Responsible Investment Association’s board of directors.

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