Jerry is married, with four young-adult kids. He’s the primary decision maker for his family’s investment portfolio. He grew up watching his parents put everything they had into their business and wants to honor their legacy by preserving and growing the wealth they created.
His youngest daughter, Tina, has just graduated from college and is starting her first job. She’s also beginning to pay attention the family’s portfolio. And she has lots of questions: Company XYZ is using prison labor to make its products—I don’t want to support mass incarceration. What’s with these coal companies in our portfolio? They’re ruining the environment. And who uses coal anymore anyway? Why do we own companies that don’t support gender equality? Why aren’t we investing in companies led by women?
Jerry sympathizes with these concerns. But he thinks the point of the portfolio is to enable his kids to start their lives and careers on the right foot, not to try to solve global warming. We already contribute to charity, he tells himself. Let’s just let the portfolio be and not mess with our investment plan. For now Tina will live with that. But she won’t forever.
Does it have to result in a family feud? Is there a way to give Jerry comfort that he’s being financially prudent and give Tina confidence that the portfolio isn’t at odds with her personal principles?
Responsible investing captures a new generation
Millennials are certainly not the first generation to care about the environment, social justice, or racial and gender equity. What appears to be unusual is the way younger investors want to address these issues in their investment portfolio.
Related: Why Donating Stock to Charity Beats Giving Cash
According to a 2018 survey conducted by U.S. Trust, 80% of high-net-worth investors of all age groups agreed that companies should take responsibility for their impact on the environment and social well-being. In fact, baby boomers and their parents had slightly higher rates of agreement than millennials did. This shows that expectations for corporate responsibility don’t differ markedly by age.
However, when asked whether a company’s environmental, social, political, and governance track record was important to the investment decision, 87% of millennials agreed, compared with just 39% of their grandparents (the “silent” generation). And 77% of millennials indicated they were interested in ESG investing, compared with an average of 40% among high-net-worth investors in total. Differences in investment priorities may not be limited to generations, yet clearly the data is telling us that younger investors are more galvanized around responsible investing than their forebears. So how to reconcile these differences?
Understanding the investor’s goals
The good news is that there’s a way to find common ground and build portfolios to suit multiple stakeholders. It involves listening closely to what investors are saying and being precise about how to achieve their goals.
For example, let’s return to Tina, Jerry’s thoughtful daughter. She listed a number of very different concerns: social justice (prison labor), environmental protection (coal), and gender parity (women in leadership roles). These sound like very different issues, but you can map them back to just two kinds of goals.
Investors often have a strong sense of which companies are “good” and which are “bad” and want to own only the “good.” This is one kind of goal, and it has a common solution: constructing the portfolio to filter out the “bad” companies according to an investor’s principles and invest in only the “good” ones.
But sometimes what investors are really saying is that they want the “bad” companies they own to be better. This is a different goal, with a different potential solution: active ownership.
The first goal results in performance deviations between the portfolio, made up of only “good” companies, and the benchmark, composed of both “good” and “bad” companies. Of course, this deviation could be positive or negative, but investors like Jerry are typically focused on the potential for the latter. There are ways of addressing this—in particular, understanding exactly how many companies still qualify as “good” under Tina’s criteria and how likely their performance is to differ from that of the “bad” companies. That’s certainly a conversation worth having.
But an even better way to start the conversation is with the second goal: active ownership. It may be that Tina wants to influence the “bad” companies. In this case she needs to continue to hold them in the portfolio so she can vote on proposals to constrain greenhouse-gas emissions or call for new policies to diversify the board. She might even want to participate in filing a shareholder resolution to put new items on the board’s agenda.
If everyone proceeds by simply trying to build a portfolio of only Tina’s “good” companies, she might never have the opportunity to achieve her true goal. Furthermore, a screen could create unnecessary tension, with Jerry worrying about performance differences between Tina’s “good” and “bad” companies.
Now, to be fair, active ownership isn’t always a realistic solution. Shareholders might be able to encourage a coal company to pay more attention to worker safety or reduce pollution from operations, but they aren’t going to turn it into a solar-power producer. Simply removing the company from the portfolio may actually be the best solution for Tina. But it may be that once the screen is precisely defined and analyzed, Jerry could gain more comfort with the potential impact on the portfolio.
The bottom line
Helping investors understand their options begins a conversation that bridges the gap between those focused purely on performance and those focused on incorporating ESG concerns into their investment portfolio. Ideally we want to use screens precisely and only when necessary and use active ownership when investors want to influence company behavior. It’s not always easy to find the right solution, but getting there requires listening—and once you’ve listened, helping investors make sense of their choices.
Potential Parametric Solution
For more than 20 years, our Responsible Investing capability has offered a robust and continually evolving menu of ESG screens and licensed indexes, giving investors a wide range of portfolio design choices. In addition, our proxy-voting guidelines follow corporate-governance best practices to safeguard shareholder capital, and they consider the relevant environmental and social implications of management and shareholder proposals.
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