Integrating ESG Considerations into Wealth Management
What is ESG in wealth management? The acronym consists of three words: Environmental, Social, and Governance. These are the metrics that many modern investors apply to their efforts, though we need to underline that these are not mandatory. In this article, we shall explain it in more detail. We invite you to read on!
What Is ESG in Wealth Management?
ESG stands for Environmental, Social, and Governance, the three principles that investors often apply in wealth management. The abbreviation is often used interchangeably with terms like ethical investing, socially responsible investing, green investing, sustainable investing, or even impact investing. The idea behind it is simple: making investments with the impact on society in mind, not purely for profit.
Interestingly enough, the principles behind ESG weren’t coined in the 21st century. The earliest mentions date back to the 18th century when John Wesley and Adam Smith highlighted the environmental dangers of certain business practices. The first responsible investor is considered to be the US Pioneer Fund, established in the early 20th century, which avoided investing in alcohol and tobacco.
The idea quickly gained popularity, with the creation of the first socially responsible stock index, Domini 400 Social, at the end of the 20th century. Although the term ESG was not yet used, the concept was described by:
- TBL/3BL—Triple Bottom Line,
- People, Planet, Profits.
The term ESG was first used in wealth management only in the 21st century; hence, it might feel like something new, although it really isn’t.
ESG Considerations in Wealth Management
ESG is a broad term. Therefore, the focus of wealth managers is often gathered around only a few of its principles, potentially overlooking others. That’s why we want to break down the three components of ESG for you and show you its meaning inside-out.
Environmental
Environmental considerations touch upon more than just climate change and reducing the carbon footprint. They also include:
- stranded assets,
- natural resources (and their depletion),
- energy efficiency,
- waste management,
- biodiversity,
- water and air pollution,
- water scarcity,
- cleantech,
- green energy,
- climate tech.
Social
Social considerations revolve around the impact of investments on the people. They include aspects such as:
- diversity, equity, and inclusion (DE&I),
- supply chain labor standards,
- social opportunity,
- human rights,
- customer satisfaction,
- data protection and privacy,
- community relations.
Governance
Governance considerations are focused on the way companies are run. They take into account aspects like:
- board composition,
- executive pay,
- business ethics,
- tax transparency,
- bribery and corruption,
- lobbying,
- political contributions.
Integrating ESG Considerations into Wealth Management
How do you integrate ESG into your wealth management firm? This requires a well-thought-out strategy for a given client.
First of all, you need to define your objectives and determine which ESG investments are appropriate for your client. Secondly, you need to analyze the regulatory landscape and shape your strategy. Finally, you should identify the gaps between the current client portfolio and the desired state after the integration of ESG considerations.
With all of that done, it is time to put the plan into action. Create a roadmap for the key stakeholders (and for you to follow), set KPIs, and start implementing the ESG principles in your investments. If you are running a more personalized business, such as a family office, you should also consider integrating the same values into your internal company culture and operations. After all, if the clients wish to follow ESG considerations in their investments, they will more than likely appreciate it in their wealth management partner.
Why Is It Worth Embracing ESG in Wealth Management?
Adopting ESG considerations in your wealth management strategies has several benefits, many of which can significantly impact your business. We have listed the most important ones below—take a look at them.
Tax Optimization
In many cases, ESG investments enable you to optimize taxes, namely by reducing them or mitigating risks. Often, even if you cannot reduce the tax via sustainable and socially responsible investments, you can reap other benefits, like myriad credits and governmental incentives. However, you have to remember that the legal framework evolves rapidly, along with the ESG itself.
Improved Risk Management
Integrating ESG into your investment strategy means spending more time and choosing your assets after more thorough research. In the end, this leads to selecting safer investments, reducing the overall risk.
Higher Profitability
According to research conducted by Morningstar, ESG investments outperform their traditional counterparts in the long run. Hence, despite the non-financial principles, embracing Environmental, Social, and Governance assets leads to higher profits for your clients.
Attracting New Clients
Currently, you can even find wealth management firms with services dedicated exclusively to ESG investments. This shows the high demand, which you can turn into a competitive advantage. After all, if a potential client sets their sights on socially and sustainably responsible investments, they will be looking for organizations that excel in this segment.
The Takeaway
Let’s recapitulate. What is ESG in wealth management? This term refers to socially, environmentally, and organizationally responsible investments. Integrating ESG brings numerous profits, from tax optimization to better risk management and even a higher attractiveness for potential clients. Since we’re living in an era when social and environmental issues are in the spotlight, we highly recommend practicing and embracing ESG considerations in your wealth management services—it’s bound to gain more popularity.
You may also read: 6 Wealth Management Trends to Watch
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