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A Fear Keeping Advisors From ESG Investing

Advisors are not leading the record-breaking adoption of sustainable ETFs. “A key challenge is that advisors are not incentivized to raise the topic with clients,” says a new report by Cerulli Associates.

Investors in general made 2021 a record-breaking year for sustainable exchange-traded funds, but financial advisors aren’t leading the charge. This begs the question: Why aren’t more advisors recommending ESG investments?

According to a new report published by Cerulli Associates, a Boston-based consulting group focused on wealth management, U.S. ETF assets topped $7.2 trillion at the end of 2021, a full $1.7 trillion higher than the previous year. 

Within that total, sustainable ETFs and mutual funds attracted a record $69.2 billion in net flows in 2021, a 35 percent increase over the previous record set in 2020, according to a report this week by Chicago-based investment research and services company Morningstar. At the end of 2021, assets in sustainable funds, including ETFs and mutual funds, were a record $357 billion, more than four times the total three years ago, the report said. 

Investor demand for environmental, social, and governance (ESG) offerings, not just ETFs, has grown in recent years, but advisors have consistently underestimated the demand for ESG investments. A new report by Cerulli suggests that not only are advisors underestimating demand, but that sustainable ETFs also present a difficult sell to advisors, who are actively choosing not to pursue them.  

“A key challenge is that advisors are not incentivized to raise the topic with clients,” the report states. One possible reason for this is that advisors may be concerned about upsetting a client who doesn’t believe in sustainable investing, Daniil Shapiro, associate director of product development at Cerulli and lead author of the report, told RIA Intel.

Another, he said, is that finding an allocation that aligns with a client’s views can be difficult. Similarly, “greenwashing” — a term used when a company claims to have an environmental impact that it can’t back up — also presents an issue for advisors.

The proof is in the numbers.

In the third quarter of 2021, a Cerulli survey of 30 ETFs issuers — representing more than 90 percent of the U.S. ETF market by assets and hundreds of advisors — found that 58 percent of ETF issuers believed there was still unmet demand for sustainable ETFs, the highest response rate of all the ETF categories surveyed, including alternatives, U.S. fixed income and emerging markets.

In contrast, just 28 percent of the advisors surveyed believed that sustainable ETFs had unmet demand. Shapiro said that this represents a huge gap between those offering products and those using them, and in fact is the largest gap between issuers and advisors in any category.

According to Ben Johnson, the director of passive strategies and ETF research at Morningstar, total assets for sustainable ETFs in the U.S. stood at $118 billion as of February 1, a drop in the bucket compared to the $7.2 trillion total U.S. ETF assets. And advisors only make up a small portion of the demand for sustainable ETFs, most of which is driven by institutions.

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The advisors who are investing in sustainable ETFs are doing so through model portfolios. Some models are ESG-focused and others that advisors are investing in just happen to have sustainable ETFs in them, Johnson said. For example, BlackRock, the world’s largest asset manager that recently passed $10 trillion in assets, began in January 2020 including the iShares ESG Aware MSCI USA ETF, one of the largest sustainable ETFs, in some of its popular iShares model portfolios, Johnson said.

“This was done not with an eye toward greening up that line of portfolios, but more so based on an investment thesis specifically — they think that investor interest in ESG intentional strategies is going to be favorable for the stocks that find themselves represented in those portfolios,” Johnson said.

Institutional clients and asset allocation portfolios have had a meaningful impact on sustainable ETG flows, Shapiro said. “I think it remains to be seen if advisors will full force adopt a lot of these products [sic]; we would expect [advisors] to increase adoption in the future.”       

Focusing on the ability of sustainable exposures to outperform, and the relevance of such investments to the next generation of clients, could be a remedy for advisors who are leery of suggesting sustainable EFTs, the report said.

In recent years, many tools have come along to help advisors break down these barriers to ESG investing. Ethic, a separately managed accounts platform for wealth managers that is focused on environmental, social, and governance investing, has grown to more than $1 billion in assets under management in only three years and is backed by royal investors Prince Harry and Meghan, the Duke and Duchess of Sussex. In November 2021, Yourstake, a platform founded in 2018 that helps advisors and asset managers identify their clients’ ESG values and model portfolios that align with their personal values, became XY Planning Network’s first ESG focused tool. 

Holly Deaton (@HollyLDeaton) is a staff writer at RIA Intel and based in New York City.

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