Ask Your Advisor About Sustainable Investing

…since our regulations don’t mention it.

Ian Tam, CFA 24 August, 2021 | 1:48AM
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Advisors

There’s regulatory change in the air. At the end of this year, Client Focused Reforms (CFRs) will hit the ground, and in our opinion will set a higher minimum bar for all advisors in Canada. The changes were designed to ensure that advisors put “client’s interests first” by ensuring proper documentation of your financial situation including your capacity and willingness to take risks, as well as a heavier requirement to understand products that they recommend (including their fees, risk and suitability for your investment style). Despite all this good news, we can’t help but notice that in the sea of regulatory documents surrounding these new changes, phrases like “sustainable investing” or “ESG” are missing.

If the intent of the new regulations is indeed to put the client’s interests first, our opinion is that this should include understanding investor preferences about investing in a sustainable manner.

Though at present there is no formal regulation from Canadian regulators in identifying and classifying sustainable investments, we do not believe that this should preclude advisors from recording and understanding whether an investor wants to invest sustainably. In addition, environmental, social and governance risks can often be financially material, and consideration of said risks would be prudent.

Sustainable investing is growing quickly in Canada. According to Morningstar’s data, the assets invested in Sustainable mutual funds and ETFs from Canadian-domiciled fund manufacturers at the end of the second quarter of 2021 totaled $26 Billion, representing a year over year growth in assets of 130%. We expect that retail demand for investing sustainably will continue to rise exponentially. 

Exhibit 1

Our data also indicates that globally, mutual funds and ETFs that follow a sustainable mandate (according to their prospectuses) have performed in line with their non-sustainable counterparts on an after-fee basis. Locally, of the 38 sustainable funds with a 10-year track record from Canadian-domiciled fund companies, 21 of them have outperformed their respective category peers on an after-fee basis. 

Exhibit 2

A possible argument against the use of sustainable investments in other countries (namely the U.S.) is the perception that sustainable products are more expensive. If a product charges a higher fee for an ESG-related feature, placing your assets in said product may not be in your best interest. This said, there is no evidence of this to be the case in Canada. Based on October 2020 data, it was found that sustainable funds and ETFs from Canadian-domiciled fund manufacturers exhibited asset-weighted median MERs that are close or in-line with non-sustainable funds.

Exhibit 3

It can also be argued that that retail consumers that invest in portfolios that are in-line with their personal values are more likely to remain invested during market drawdown periods resulting in better long-term outcomes. This was observed in Canada during the COVID-19 pandemic selloff in March. According to Morningstar’s data, while traditional mutual funds and ETFs experienced net outflows close to $13 Billion in March of 2020, funds that Morningstar identified as sustainable (ESG funds, Impact Funds, and Environmental Sector Funds) experienced net inflows of $646 Million. Given that the size of the sustainable fund market in Canada is still small (roughly 1% of total assets) the trajectory of inflows during the most recent selloff shows anecdotal evidence that this is true in our market.

So even though it is not a regulatory requirement for advisors to understand whether you prefer investing sustainably, it certainly doesn’t hurt to mention this interest to them, and maybe educate them about what’s out there. It’s a fast-growing space with lots of opportunity for you and frankly for your advisor as well.

This article does not constitute financial advice.

 

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About Author

Ian Tam, CFA  is Director of Investment Research at Morningstar Canada. 

 

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