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Values-based Investing: Going Beyond ESG

Max Mintz August 23, 2023

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ESG analysis has become a buzzword for the rise in focus on social responsibility when it comes to investing. Yet companies have been managing their environmental, social, and corporate governance risks for years. In fact, “ESG” as a term was first used in the 2006 United Nations Principles for Responsible Investment (PRI) Report1 and has since grown to be the primary means for investors and business leaders to discuss the message behind these standards.

As a professional working in this space, I’ve been in many conversations where I find a fundamental difference between what people are looking for and what they’re getting—i.e. the difference between investments informed by ESG analysis and those doing values-based investing. My hope is that this piece will help both individual investors and financial professionals understand the difference between the two.

Additionally, by understanding the role financial professionals play in helping clients navigate their options, I hope to give other professionals tools to increase engagement in the financial planning process.

Understanding the Basics of ESG

ESG analysis is a form of risk management. The term ESG refers to the examination of how the risks that environmental, social, and governance factors pose are ‘financially material.’ In other words, how well a company is managing these ‘extra financial’ risks, their impacts, and the company’s progress against benchmarks and—usually—against their peer group. A wide range of entities, including investors, lenders, government agencies, communities, customers, employees, and others, have a stake in ESG performance.

For example, from a financial perspective, investors and lenders may rely on ESG data, including related scores or ratings, to assess a firm’s risk exposure as well as its possible future financial performance. On the other hand, communities and consumers may want to know about a company’s environmental and social practices to inform their advocacy and purchasing decisions.

Values-based Investing and How It Differs From ESG

Years ago, when I began evaluating ESG metrics of companies or funds looking for investment opportunities, there were many available that received high ratings. However, these ‘highly rated’ companies sometimes had products or services that actively conflicted with the values of my clients. Since those values are what my client conversations were focused on, this had the potential to lead to conflict or unsatisfied clients.

As I started getting deeper into the work of helping clients invest according to their values while building portfolios using Modern Portfolio Theory, something wasn’t adding up. There are investment funds that are marketed as ‘sustainable’ that might be heavily invested in extractive fossil fuels or have other business involvements that clients didn’t feel comfortable with. I needed a way to customize my clients’ investments to align with their values.

When I was first coming to this revelation, the right tools didn’t exist. We had to ask, “What data can be used?” and “How should we be thinking about this?” Simply put, the ESG metrics that existed weren’t answering my clients’ questions.

Because ESG analysis is a form of risk management, it looks at how environmental, social, and governance data points could potentially impact a company’s bottom line. How they materially impact a company’s profitability and their stock price. That’s important information, but what my clients wanted to know is how the companies they are investing in are impacting people and the planet while still being profitable.

So, that’s what we began to look at. We realized it’s not the same thing. In fact, these things are almost moving in different directions. While a fund’s marketing materials may say they are green or sustainable in certain ways, we had to dig deeper into their methodology documentation to understand what was below the surface.

Data Is Key to Values-based Investing

Data is critically important to ensure I’m helping my clients invest the way they want. It’s also important that the fund managers, risk managers, and people who are picking stocks have meaningful data to help them make decisions when deciding between investing in Company A or Company B, particularly when the only differences between them are material ESG factors.

But here’s the thing, I’m not a fund manager. I’m a retail-facing financial advisor whose job is to manage the asset allocation of my client’s financial plan and to help them align that plan with their values. It’s a different approach entirely.

Before I go deeper here, it’s important to acknowledge that ESG data does have a use, and I actively want to see fund managers using it—it just doesn’t answer the questions my clients are asking. In fact, when I conduct due diligence on a fund that claims to use sustainability data in its investment process, one of the first questions I ask is, “How did you select your sustainability data vendor and why do you feel that the data you use helps you make better decisions?”

I needed to be able to answer that question myself, and the first step was getting access to a data set that I and my clients could trust—one that never uses a ‘black box’ to make decisions about what matters to my clients. It didn’t exist at the time, so we had to build it. In my case, the result was a deep partnership with YourStake.org—which built a toolset specifically to allow me to do this work and have these conversations with my clients. There are now several other similar options available, which I view as healthy competition.

The critical thing for me in selecting this vendor was where the data is coming from. Sourced from NGOs and nonprofits with boots on the ground in the areas they specialize in, the data we work with means we never need to ask our clients to trust that we’re making decisions about their values for them. What these tools have allowed us to do is report to our clients on data that matters to them and know that the data is coming directly from stakeholders that have identified for us what matters to them. This helps immensely in our role as planners in facilitating investments that are in line with our clients’ values. Here’s an example of how this could be applied.

If a client comes to me and wants to talk about divesting their portfolio from fossil fuels, the first course of action is to identify and eliminate companies that have any obvious exposure. These days, the task of identifying companies that actually pull fossil fuels out of the ground is pretty easy, and you can get that data from a number of sources. But we also have to talk about edge cases. What about a fund that is fossil fuel free by prospectus but may invest in a solar company that’s a subsidiary of an oil company?

That solar company is not involved directly in anything involving fossil fuels. However, its profits may flow up the corporate ladder, eventually supporting the oil company. What we’ve accomplished is a means of subsidiary mapping that I can use to report back to my clients by flagging that company as an oil company. This leads to a deeper conversation about whether that holding is acceptable to them.

Technology Is a Critical Component of Values-based Investing

Technology provides a means to do the research and manage the data to help us guide our clients with transparency, but because sustainability and values mean different things to different people, it’s also a lot of work to cater to so many different investment strategies—and technology is key to managing those strategies.

My solution has been to manage a series of model portfolios that represent our ‘house view’ on sustainability. We’ve found that it can be intimidating to start by asking a client what matters to them. You need to have a starting point to avoid analysis paralysis, or the ‘deer in headlights’ look. The goal is to build a process to get to a place where you can say with confidence, “I believe that this set of funds or set of investments represents what my client is looking for.”

We begin by sending the client a link to an online questionnaire that filters their values and lets us generate a report that breaks our reporting into five different metrics: human health, environmental issues, human rights, equal opportunity, and accountability. Critically, the outputs from that survey represent a starting point toward having deeper conversations with the client.

As with any questionnaire, blindly trusting the outputs can be just as problematic as not using a tool like this at all. Once we have discussed the questionnaire, and refined what our clients care about, I can use it to further filter down the database and generate an initial report which we review together—it’s sort of like going through layers of an onion.

As we review the report, we can drill down through the funds in the portfolio to view the actual holdings and expose those edge cases, which gives the client an opportunity to explore what is and isn’t acceptable in support of their values. Using technology to manage the data and the models helps to simplify these complex processes.

Worth the Effort for Deeper Client Relationships

Establishing a practice that focuses on values-based investing can be daunting. The good news is that there are tools and technology that can help level the playing field for the variety of value sets you will encounter. Through our values discovery process, we’ve gained a better understanding of what matters to our clients, and this information in turn informs our life planning and financial planning processes and results in a deeper relationship with clients.

Using my firm to create a better world for future generations is something that is important to me, and I’ve found that helping my clients invest with their values and conscience is a very fulfilling way for me to have a positive impact. We are, after all, advisors, and our job is to advise and counsel—to help clients examine abstract concepts like risk and return, and guide them to a plan that fits those constraints.

I view conversations about sustainability and values as additive, not subtractive—an additional layer that helps build confidence in a plan. It’s important not to forget the body of knowledge that makes up financial planning, but to use these techniques to empower more clients to make a plan and stick to it.

Source:

1Betsey, Atkins. “Demystifying ESG: Its History & Current Status.” Forbes.com, 2020. June 8. https://www.forbes.com/sites/betsyatkins/2020/06/08/demystifying-esgits-history–current-status/?sh=676dfbfb2cdd.

DISCLAIMER: The eMoney Advisor Blog is meant as an educational and informative resource for financial professionals and individuals alike. It is not meant to be, and should not be taken as financial, legal, tax or other professional advice. Those seeking professional advice may do so by consulting with a professional advisor. eMoney Advisor will not be liable for any actions you may take based on the content of this blog.

The views and opinions expressed by this blog post guest are solely those of the guest and do not necessarily reflect the opinions of eMoney Advisor, LLC. eMoney Advisor is not responsible for the content, views or opinions presented by our guest, nor may eMoney Advisor be held liable for any actions taken by you based on the content, views or opinions of the guest.

Max Mintz is the owner of Common Interests, LLC. You can learn more about him and his firm at: www.commoninterests.com he is also registered as a financial advisor with Vanderbilt Financial Group.

Common Interests, LLC is not a registered broker-dealer nor a registered investment advisor. Common Interests, LLC and Vanderbilt Financial Group are separate and unaffiliated entities

Vanderbilt Financial Group is the marketing name for Vanderbilt Securities, LLC and its affiliates. Securities offered through Vanderbilt Securities, LLC. Member FINRA, SIPC. Registered with MSRB. Clearing agent: Fidelity Clearing & Custody Solutions. Advisory Services offered through Vanderbilt Advisory Services. Clearing agent: Fidelity Clearing & Custody Solutions Insurance Services offered through Vanderbilt Insurance and other agencies Supervising Office: 125 Froehlich Farm Blvd, Woodbury, NY 11797 • 631-845-5100

For additional information on services, disclosures, fees, and conflicts of interest, please visit www.vanderbiltfg.com/disclosures

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About the Author

Max Mintz is a Partner and Financial Planner at Common Interests, a holistic financial advisory firm specializing in Sustainable, Responsible and Impact Investing. Common Interests is a Certified B Corp®, a designation the firm pursued to demonstrate verified commitment to social and environmental responsibility, and track their progress over time. In 2019, Max was honored as a “40 under 40” advisor by InvestmentNews, which he ascribes to the firm’s commitment democratizing access to both financial services and impact investing.

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