How advisors figure out which ESG funds are a good fit for socially conscious clients and their portfolios

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When introducing clients to the idea of sustainable, or socially responsible, investing, financial advisors' questions often spark a revelation.

"Our first question to any potential client is about values," said certified financial planner Mitchell Kraus, co-founder of Capital Intelligence Associates in Santa Monica, California. "What do you want to do for your children? Parents or other relatives? Community? World-at-large?

"Based on your values, are there any companies you want to avoid?" he added. "Or are there any investments you want to focus on?"

"The No. 1 answer is 'I never thought about that,'" Kraus said.

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Exploring and choosing to invest sustainably is a personal and unique experience, and there are multiple strategies under the sustainable umbrella, said Amber Miller, CFP, senior financial planner with The Planning Center in Maple Grove, Minnesota. She begins by asking clients if they are interested in learning more about sustainable investing and, if so, discusses the difference between the "E," or environmental; "S," social; and "G," for governance, factors that underpin these types of investments.

Miller uses the opportunity to bring up related financial planning subjects.

"We discuss charitable giving and investing in local activities and businesses which may not have the same expected returns, but support the overall goals of the client by contributing to the world the client would like to see," Miller said.

For his part, Ben Smith, a CFP and founder of Milwaukee-based Cove Financial Planning, asks clients, "What does sustainable investing mean to you?"

"I've found that sustainable or impact investing often means different things to different people," he said. "Some investors take a more 'social' approach to this type of values-based investing, meaning they want exposure to companies with diverse talent and leadership, a strong ethical background and solid corporate governance policies.

"In a nutshell, they want to invest in companies that treat people fairly," Smith added.

Other investors emphasize a sustainable approach to values-based investing, Smith said, wanting to invest in companies that are reducing carbon emissions, reducing greenhouse gases and taking other green initiatives seriously.

He also asks about what he calls non-negotiables.

"Many clients, for various reasons, don't want their portfolios invested in [industries] related to [for example] gambling, tobacco, firearms, etc.," Smith said. "It's important for me to understand why this is important to each client and even more important for them to know how we can build a diversified portfolio around these non-negotiables that aligns with their long-term goals."

Rolling sustainable funds into portfolios

When rolling sustainable funds into client portfolios, Smith often starts with low-cost, broad-based exchange-traded funds or funds with a social or sustainable focus that meet portfolio allocation needs.

"For example, many asset managers offer U.S. Large Cap ETFs that reduce exposure to companies that are poorly rated from an ESG/SRI perspective," he said. "The benefit to the client is that they can gain broad-based access to major asset classes … while still fulfilling their preference for value investing.

"From there, we add exposure around these specific asset classes based on each client's unique preferences and sensibilities," Smith added.

Some clients see sustainability as a risk-mitigation strategy by avoiding poor corporate actors or risky areas, said John McGlothlin III, CFP, a financial planner with Southwest Retirement Consultants in Austin, Texas.

It's the idea of voting with your wallet, of people collectively moving the world to where they want it to be.

Mitchell Kraus

co-founder of Capital Intelligence Associates

For these types of investors, "it may be enough to recommend an ETF that simply avoids certain industries and overweights companies with better sustainability numbers," he said. "For those wanting their values reflected, we tend to recommend actively managed funds that not only pick best-in-class companies but also take actions to improve corporate behavior, whether through proxy voting or shareholder activism measures," he added.

It's important to be aware of costs that may arise when bringing a sustainable orientation to the portfolio, said Kevin M. Gahagan, CFP and principal with Private Ocean in San Francisco.

"Typically, this is a question of realizing capital gains in replacing existing investments," he said. "This doesn't have to be an all-or-nothing proposition.

Gahagan notes that moving toward a more sustainable approach can be a gradual process. "In some cases — for example, where all assets are held in tax-deferred accounts — shifting to a sustainable/ESG orientation can be as fully realized as the client may wish," he said. "However, if incorporating a more sustainable focus will involve realizing gains, then we'll want to discuss establishing a budget for the amount of gains that might be realized."

"How much exposure to taxable gains, if any, is the client willing to incur?" Gahagan noted. "This guidance will influence how we'll be able to proceed in bringing this focus into the portfolio."

Beyond good intentions and financial return, a significant by-product of a sustainable investing approach can be a feeling of empowerment.

"It's the idea of voting with your wallet, of people collectively moving the world to where they want it to be," Kraus said.

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