By: Mukund Rao and Neil W Dsouza

The recently concluded The United Nations Climate Change Conference(COP26) that was held in November 2021 in Glasgow not only demonstrated the progress made on the momentous Paris Agreement of 2015, but also brought out the challenges in the long road ahead towards realizing the net-zero emissions target by 2050. An enormous commitment is required by all countries, especially the larger ones.

Finance is a key aspect, and it’s estimated $123 trillion will be required to help meet the target goals. Financial institutions such as investment banks and investment managers are at the forefront and have pledged their commitment to the cause by being signatories to or partnering with organizations such as UN PRI, Ceres, TCFD, UN SDG, and the Net Zero Asset Managers Initiative. It also provides an opportunity to be the channel for green money and be catalyst for positive change.

However, investment advisers have yet to come to terms with the macro shift in investing. A recent SEI survey of nearly 800 registered investment advisers showed that while 80% indicated client demand as the primary driver of incorporating sustainable investing strategies in a portfolio, only 34% of RIAs have implemented sustainable investing strategies for their clients.

Possible reasons are plain inertia and lack of understanding, as well as the extra effort and due diligence it takes to analyze ESG investments. Additionally, there is concern that the higher expense ratios of these investments may take up a larger portion of the fee budget, although numerous studies have indicated that correlations between ESG scores and market value are positive and significant across all regions.

Given the increasing awareness and demand from clients and prospects, it’s imperative that financial advisers get fully educated on ESG and stay abreast of fast-moving changes.

While that’s the starting point, integrating ESG or handling exclusions into the investment advice and portfolio management processes requires commitment and the appropriate tools to achieve the mission. Fortunately, digital transformation and artificial intelligence have democratized financial advice, and now with ESG integration, it can even be offered to the mass affluent and retail investor segments.

In terms of fintech tools, small to midsize advisers should look at ESG capabilities with their investment management platform providers or from stand-alone external providers.

Larger advisers, wealth managers, and investment managers who run their own investment, risk management, and research technology platforms have more choices. They can either implement an ESG-focused platform that helps with ESG integration or build on top of existing research and portfolio management capabilities. In the case of the former, data integration into vendor platforms is the primary effort, while in the case of the latter, a larger effort is involved.

For those looking to establish their own platform, the following framework — which includes structures and processes to ensure the reliability and consistency of data analysis and decision-making — can be handy. This framework is based on five pillars:

• Assessing the current state of ESG data. Identify what data is currently available, along with potential gaps in the available data relevant to ESG standards. Determine a solution for sourcing the remaining data needed to gain a complete picture of each company in a firm’s portfolio.
• Establishing an accessible data hub. A data hub collects data from multiple sources so that everyone across the firm can access, edit and draw insights from the data. For investment firms, a data hub is where the data portfolio, analysis, and repository would reside. Cloud-based data hubs enable more flexibility and ease of use.
• Developing an intelligence layer. Using artificial intelligence and data analysis tools will help investment firms better manage and draw insights from their ESG data. Specific lines of business can develop individual data models to enable more customized decision-making.
• Establishing an ESG reporting capability. Customers want complete transparency to be confident that ESG standards are being met. Developing reporting, disclosure, and governance processes is key to providing that level of trust, compliance, and transparency.
• Using front-end data visualization tools. Data visualization tools — charts, maps, graphs — allow us to ingest large amounts of data quickly and understand trends, patterns, and relationships. This is vital for managers who need to quickly assess the ESG status of companies in their portfolio.

Regardless of whether financial advisers and investment firms want to lean on vendor services or develop and expand on existing capabilities, integrating ESG into investment management is vital, and delaying its adoption is fraught with great risks.

There’s an incredible opportunity for firms to differentiate themselves with smarter, more informed, data-driven decision-making in research, by providing advice, and monitoring the ESG performance of their client’s portfolios.

Those firms that establish the right business architecture and employ appropriate fintech tools to integrate ESG into their financial advice management will more likely earn the trust of their clients and translate that trust into long-term partnerships.