Ethical investing can mean different things to different people. So, how do you talk to your clients about this style of investing? Jayson Forrest asked three CFP® professionals who specialise in ethical investing.

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Name: Dave Rae CFP^®

Position: Financial Adviser

Practice: Federation Financial Services

Licensee: FYG Planners

Years as a financial planner: 18 years

Name: Farren Williams CFP^®

Position: Adviser and Partner

Practice: Koda Capital

Licensee: Koda Capital

Years as a financial planner: 19 years

Name: Chris Giaouris CFP^®

Position: Partner and Principal Adviser

Practice: Chronos Private

Licensee: Fitzpatricks Private Wealth

Years as a financial planner: 13 years

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Whether it’s environmental, social and governance (ESG), socially responsible investing (SRI) or impact investing, the value of an investment is no longer just about returns, as an ever-increasing number of investors want their money to make a positive impact on society and the world in which they live.

Ask Dave Rae CFP^® – a financial adviser at Federation Financial Services – to describe the type of investor drawn to ethical investing and he concedes there is no typical age, gender or generation attracted to this style of investing. Instead, the one common trait shared by investors is a desire to make positive change in the world they live.

“The clients I deal with all care about the same sort of things – whether that’s climate change, sustainability, energy efficiency and human rights issues,” Dave says.

It’s a view shared by Chronos Private partner and principal adviser, Chris Giaouris CFP^®, who adds that the type of client drawn to ethical investing typically have a responsible, ethical and green philosophy in what they do in life.

“These are people who have fundamental beliefs in the science and facts around carbon emissions. They believe in the impact and damage that some industries and companies are having in the world and want to make a beneficial change through the way they invest,” Chris says.

“They want to make a difference, and they want to ensure that their investment portfolios do not support certain industries, sectors and practises, like gambling, tobacco and child labour.

“So, ethical investing isn’t constrained to one type of client demographic. Instead, investors are drawn to this type of investing based on their philosophies and beliefs about ESG issues.”

In contrast, at Koda Capital, adviser and partner, Farren Williams CFP^®, deals with two types of clients – wealthy families/individuals and non-profits/charitable foundations. Both types of clients are attracted to ethical investing but the conversations and issues surrounding this type of investing can be quite different for them.

“For our private clients – wealthy families/individuals – ethical investing is about an alignment of their personal values. This includes what they don’t want to invest in, as well as what impact they want to achieve in the world, which might revolve around issues they are particularly passionate about and sometimes, about leaving a legacy of positive change,” Farren says. “For families, it is also often a conversation that is further enriched through bringing in multiple generations of the family.”

“And for the non-profits, it’s typically around value-alignment, mission consistency and reputation risk management, with impact considerations often coming in as a distant third for investing ethically. Stakeholder expectations and engagement are often also important in how they frame-up their ethical investment policy. Boards of non-profits tend to be more reticent when it comes to making less liquid impact investments, though we are seeing greater appetite here than a few years ago and we are incorporating this into their portfolio design.”

Talking to clients about ethical investing

When Dave first got involved with ethical investing six years ago, he initially waited for clients to first raise any ethical considerations they had with him. But as his knowledge around this style of investing improved, so too did his approach to discussing ethical investing with clients change.

“I now incorporate ethical investing as part of my conversation with clients, both new and existing,” Dave says. “And in so doing, I’ve discovered that people, regardless of age or gender, are overwhelmingly interested in this type of investing.”

But Dave concedes it takes the “right type of conversation” in order for him to draw out his clients’ values, goals and objectives to ethical investing.

“It starts with a simple conversation, rather than any formal documents,” Dave says. “I like to start off by discussing topical issues, like the recent bushfires and the COVID-19 pandemic. By discussing topical issues, it’s a useful way to introduce links between bushfires and climate change, or the pandemic and health-related issues, like medical research or how companies have managed their staff during these challenging times.”

Dave believes when topical issues are discussed with clients, it becomes a much easier way to link topics that clients are concerned about to their investment strategy.

At Chronos Private, Chris takes a slightly different approach when talking to clients about ethical investing. At the core of his approach is understanding where their “why” sits, as the reason to be investing ethically.

“We’re big believers in the ‘why’ and the ‘why’ around anything you do,” he says. “So, for a client, I need to understand why they want to invest ethically. Are they doing it because they think they’ll get a better investment return or they think it’s cheaper to invest this way? Are they doing this because they want to make a tangible difference in the world?

“The reasons that people invest ethically are different. But once I understand why they are doing it, that will often direct the conversation. For example, if a client tells me they want to invest ethically because they heard it’s the cheapest way to invest, then that type of conversation will go a very specific way, and suddenly, they might realise that ethical investing is not actually what they want.”

Instead, Chris takes the time to understand why his clients want to invest ethically and once he is comfortable with their reasons, he begins introducing key investment principles to his clients, including the importance of portfolio diversification and not trying to time the market. From there, he explains how responsible investing can be overlaid on top of these foundation investment principles.

“We try to link these two approaches together – sound investment principals that have stood the test of time, such as diversification, and a client’s preference/s around ESG issues,” he says.

“And when you put those two together, that’s the framework I use for building ethical portfolios and how I explain it to my clients.”

Farren takes a similar approach with her clients at Koda Capital. She says quite often, ethical issues come up through initial discovery conversations and then refined through ongoing review meetings. Farren therefore ensures she raises ethical issues with every new or prospective client, in order to understand how they would like to approach any investment issues and what their priorities are.

“I use a questionnaire that is essentially an expanded version of the Responsible Investment Association Australasia (RIAA) responsible investing fact find. This enables me to better understand my clients’ values and priorities. I also use tangible investment examples in the ethical  and impact space to help them consider if and how they would like to approach different issues.

“We work through a range of different ethical and impact areas, and build out a framework that forms part of their ethical investing policy, which then informs how we invest their portfolio. However, no two clients are the same, so we tailor the solution to each client’s needs. They have different areas of focus and different levels of sensitivity on ethical issues, and different preferences on how they want that translated to their investments.”

Farren adds there are, however, often areas of common ground amongst clients when it comes to exclusions, including gambling, tobacco, armaments, pornography, predatory lending, alcohol and human rights abuses. However, surprisingly, she says her clients have varying views on fossil fuels, with some wanting them screened, while others are prepared to take a more pragmatic approach or choose to invest in the transition to cleaner energy.

“And on the impact side, there are some investments that stack up really well across the board for clients, while there are other impact investments that are quite specific and are taken on a client-by-client basis. For example, if it’s an illiquid social impact bond tackling homelessness or a long-term solar infrastructure project, then they tend to be different client conversations compared to investments in green bonds, water assets or pharmaceutical research and development.”

Key concerns

At Federation Financial Services, Dave says the two biggest concerns his clients have with ethical investing are: investment returns and costs.

“There is a perception that investing ethically means active investing, which can be more expensive from a fund manager perspective, costing the investor more. And while that is true to some extent, there is such a broad spectrum of investment approaches and lower cost options available today, like ETFs, for investors to use when looking at ESG or sustainable investment themes. That’s how I like to address my clients’ concern about costs.”

And what about investment returns? Is there a disconnect between a client’s ethical values and their expected return on investment?

“Not at all,” says Dave. “Regardless of what my clients’ ethical values are, they’re still looking for a market rate return. They don’t want to give something up in terms of that market performance. So, clients don’t have to sacrifice returns to invest ethically.”

He points to a number of in-depth research studies, including the annual RIAA Responsible Investment Benchmark Report, which compares responsible investment funds against their broader peers in each investment sector, as well as the index.

“The research shows that in most cases, returns are at least as good as the broader market return, if not better. The report shows the average responsible investment fund for Australian equites and international equities has done better than the index in most time periods over the last 10 years.

“And groups like Morningstar and Rainmaker have looked at the performance of ESG and sustainable funds through the current coronavirus pandemic, and have found that ESG and sustainable funds, both in Australia and the U.S., have outperformed the broader market through the COVID-19 crisis.”

Chris agrees. He doesn’t see a disconnect between his clients’ ethical values and their expected return on investment.

“Fees and costs used to be a concern in ethical investing but not so much these days, as costs have become far more mainstream. So, the old adage that you can invest ethically but you’ll have poor returns and pay high fees, no longer stands true.

“Ethical investing is definitely becoming more mainstream. If companies are operating in an efficient and environmentally-friendly way, it doesn’t surprise me to see that those types of companies are performing better overall compared to others that perhaps aren’t as efficient with their carbon footprint or managing their social issues,” he says.

“If you’re investing ethically just for investment returns, then I would question that. I don’t think the concept of ethical investing and the chase for returns work well together. That’s because the moment a client’s portfolio underperforms, they will blame it on the fact that it’s an ethical portfolio and will make a knee-jerk decision to change it.

“So, it’s the responsibility of financial planners to help their clients differentiate what they mean between returns versus ethical investing. They don’t necessarily have to be linked.”

Other than the concerns investors might have investing in particular sectors and industries, Farren adds that a common client concern that she deals with relates to how fund managers are managing ethical issues with their investments, including their level of transparency, scrutiny and stewardship of the capital invested, such as exercising their shareholder voting rights.

“We manage our clients’ concerns by properly understanding what their values and priorities are and then tailoring a portfolio to their individual needs,” Farren says. “To do that we also need to understand how different fund managers are approaching these issues to make sure they are fit for purpose when used in client portfolios.”

Another concern Chris encounters centres on managing client expectations with ethical investing.

“You need to understand that people’s beliefs are not all the same and it’s vey hard for a portfolio manager to put together ethical portfolios that suit every single specific person’s preferences. You just can’t. So, people have to accept that their view on investing might not be perfectly aligned with the investment options available to them,” he says.

“Clients need to accept a flexible approach to ethical investing, while maintaining sound investment principles, like portfolio diversification.”

Common misconceptions

What about some of the common misconceptions of ethical investing? Are there any?

“Unfortunately, yes,” says Dave. And top of the list is the misconception that ethical investing is a fad and only suited to Millennials. The way he addresses these myths is to use current examples of what is happening both globally and domestically.

“A lot of the capital moving into ethical investments is being driven by some of the largest institutional investors, such as superannuation funds and pension funds. Almost every week, we’re hearing of a superannuation fund in Australia or an offshore pension fund that is divesting from fossil fuels. That shows that ethical investing is not just a fad or an option for Millennials. There are some seriously big institutions that are looking at these ESG and sustainability issues, and taking action on them,” he says.

“And in Australia, the RBA, APRA and ASIC have all talked about the need for directors to be aware of climate risk as part of their decision-making process.

“So, in dealing with these misconceptions about ethical investing, I like to talk about the approach our regulators and institutional investors are taking with responsible investing.”

Dave is quick to add that another misconception proffered about ethical investing is that this style of investing is easier to do in equities compared to other asset classes.

“Not so,” he says. “There are now more options available for fixed interest in areas like ‘green bonds’. And increasingly, we are starting to see more come out of the alternatives space. For example, some of the interesting things we’ll start to see become more accessible for retail investors are investments for disability housing, renewable projects and the like, which fit into the alternatives sector.”

In contrast, Chris struggles to identify any misconceptions surrounding ethical investing. However, one that does come to mind is the belief that clients think they have far more options and customisation available to them than is actually available.

“While we do have more investment choice and options available today, it’s still very hard for somebody with a modest retirement amount to have a specific investment portfolio that’s based on their individual ethical philosophy that’s built just for them. You can’t hold thousands of stocks and build a well-diversified portfolio if you’ve only got a small amount of money to invest. Clients need to be realistic about their expectations based on the amount they have to invest.”

For Farren, one of the objections she sometimes comes across is the view that impact investing is akin to philanthropy, not investing, which “really just opens the door to a discussion about some of the fantastic opportunities that are now available to target strong financial outcomes along with positive impact”.

“It is still a common misconception that in order to achieve the impact, you must accept a lower financial return. There is, however, often a need to accept illiquidity to achieve the long-term impact and so not all clients will be able to invest in these opportunities and most impact investments are only available to wholesale investors.”

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Top tips for talking ethical

Here are six tips to help you have an effective client conversation about ethical investing.

1. Just start the conversation

Take the time to understand what motivates your client and drives their personal values. This will help you to better work with clients on their goals and objectives as part of their approach to ethical investing. Having a conservation around ethical investing helps planners to develop a deeper relationship with their clients, because you’re encouraging a different type of conversation that is centred on your client’s personal values and connecting this to their wealth.

2. Talk about topical issues

As part of your client conversation, talk about current topical issues, like the bushfires, COVID-19 or the Black Lives Matter movement. By doing so, you can easily link these topics back to ESG and ethical issues. For example, Australia’s recent bushfire emergency and the link to climate change. By doing so, it becomes an easier way to link issues that clients are concerned about with their investment selection.

3. Become a myth buster

Use this opportunity to dispel misconceptions about ethical investing, such as sacrificing returns to invest ethically. Use available and independent research to support your views, and provide

tangible examples of investments that meet the client’s ethical needs and their financial risk and return requirements.

4. Explain your investment philosophy

Explain your approach to portfolio construction, including the importance of building a well-diversified portfolio based on sound investment principles. And then explain your approach to putting a sustainable overlay over the top of that.

5. Use a framework

Develop a framework that helps support your conversation around ethical issues. Don’t make an assumption around whether a client is interested or not in ethical investing. Ask the client about their interests and priorities about ethical and impact investing. It’s not only important to have this conversation with clients at the start of the financial planning process, but to also incorporate it as part of the regular client review meeting, as client values may change over time, new issues gain

attention and new investment opportunities will become available.

6. Link a client’s values to the investments available

Link a client’s values with relevant and available investments. This enables planners to have more targeted conversations with their clients around ethical investing, while providing clients with the opportunity to assess whether the investments are the right fit for their values and understand how they complement the other investments in their portfolio.