Future-proofing for intergenerational wealth transfer Future-proofing for intergenerational wealth transfer http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\space-lauch-system-small.jpg March 11 2022 November 9 2021

Future-proofing for intergenerational wealth transfer

Financial advisors need ESG fluency to connect with the next generation of inheritors.

Published November 9 2021
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Podcast Transcript
Linda Duessel: Hello, and welcome again to the Here and Now Podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist. Today, I'm joined, virtually, by Mary Green, a client portfolio manager focused on environmental, social, and governance, ESG, investing. Federated Hermes is guided by our conviction that responsible investing is the best way to create wealth over the long term. And today, Mary and I will talk about ESG and generational wealth transfer. Hi, Mary.
Mary Green: Good morning, Linda. How are you?
Linda Duessel: I'm great. And when I go on Federated Hermes website, the first thing I read is, Federated Hermes is a global leader in active, responsible investing. What does it mean to be a responsible investor?
Mary: That's a really good question, and it's one on many people's minds, because I don't think that there is one agreed upon definition of responsible investing. So, I'm really happy to tell you what Federated Hermes means by that. We really go back to the roots of the UNPRI, the Principles of Responsible Investment. There are six principles and our firm was a founding signatory. But we were one of the lead drafters of the UN Principles of Responsible Investment, so we have been framing the conversation from the very beginning. Mainly, it's about responsible investment and ownership, incorporating ESG issues into investment analysis and decision making. It's acting as an owner, not a trader, as someone who really cares about outcomes.
Mary: So as a responsible owner, we commit to being active owners and incorporating ESG into our ownership policies and practices. So, there are stakeholders across the entire value chain. You've got your supply chain, you've got your employees, you've got your distribution works. There's the community in which a company operates. And then of course, there's the planet itself. So, from supplier to manufacturing, to customers, to distribution, to communities and the planet, without any one of these, you don't have a company, you don't have a business. And so, you act responsibly towards each stakeholder along the way. Manage risks that pop up, if you want to have a sustainable business model. I mean, a business that's going to be around fifty, a hundred years from now.
Linda: Excellent. Yeah so, that's really interesting that Federated Hermes was involved way, way back at the beginning with the UN Principles. So now, let's go on and delve into this just a little bit more, and look at how responsible investing has evolved from what we used to call, back in the day, socially responsible investing. How's it evolved over the years?
Mary: Yeah, you're absolutely right. That was the very earliest form of responsible investing. It was for religious organizations and their pension funds, and wanting to avoid whole sections of the economy that weren't in alignment with their values. So that's called exclusions, or negative screening, and that's the very earliest form.
Linda: And what would be an example of that, Mary? For example, what?
Mary: So avoiding tobacco, fossil fuels, alcohol, anything that is in opposition to an organization's values. And it's very interesting. I like to say at Federated Hermes responsible investing is not so much about reflecting values as it is about creating value, long-term value creation. I'm going to talk about some of the new approaches and the evolution. It's not an investment approach. And that's a myth that I like to bust often. That ESG is not an investment approach. ESG is data, data that reflects corporate behavior, on corporate behaviors towards all of those stakeholders. E is of course, environmental, anything that touches the natural world. It's climate change, it's resource depletion, waste management, circular economy, that type of thing. Water. S is, the social column. So anything that touches humans, right? So it's human rights, it's human capital management. It's child labor, data security within our digital world.
Mary: So, it's all about people. G is, governance, and that's something that we've been very comfortable incorporating into our investment decision making in the U.S. for a very long time. How a company governs itself. It's board structure, share class structure, executive remuneration, that type of thing. So ESG is not an investment approach, it's data, and it's material, non-financial data that can have long term financial or operational impacts on a company. And so therefore, we need to consider it in our investment decision making process. So going back to the very roots of socially responsible investing, that was exclusions, avoiding areas of the economy to align with values.
Mary: Today, there's a whole spectrum of outcomes that investors are seeking, when they're thinking about responsible investment from pure financial outcomes to more mission driven outcomes. And I call it a spectrum deliberately, because one does not necessarily preclude the other. This is investing, after all, like you said, Linda. You want good financial return and you absolutely can with a more mission-based objective. There are different types of approaches that align along the spectrum. So clients who are just simply looking for better risk adjusted returns to get those benefits from ESG risk analysis, would go for an integrated strategy. So that is, incorporating ESG factors into the investment process in order to mitigate risk. And at Federated Hermes, 98.6% of our assets are actively ESG integrated.
Linda: 98.6%. I think that's really interesting that social responsible investing is, as we understood it years back... Like you said, I don't want a tobacco company. But, I love the way you speak about how it's data, much like when we analyze as investors to populate our portfolios. Well, I want to look at valuation, and I want to look at management turnover. And I want to look at ESG. And I thought it was very interesting that exclusion is the largest strategy over in Europe. And they've really evolved a lot.
Linda: And the U.S. is picking up big time on this, quickly. Here now, I move on to my next question for you. And just looking at how powerfully ESG investing has grown, and just in recent years. Like you said, we started back in 2005 with the principles. But I just read a statistic that, year-to-date, 3 out of every 10 dollars of global equity inflows is going into ESG. And that 2021 remains on track for a record year of ESG gathering. With flows in September year-to-date more than what they were just last year. So, Mary, who is (inaudible) ESG and why?
Mary: There's a perception out there that this is the realm of the young, the realm of millennials, and those that are poised to inherit this historic wealth transfer from baby boomer to next generation. That's true. However, there are statistics that say that 95% of millennials are interested in responsible investing. But 85% of all investors are interested. So I would say that this is a trend for everybody. However, I do want to focus on this younger generation of investors and why it's really important for an advisor, for example, to increase their ESG fluency. We actually do a survey here as well, at Federated Hermes, and we found, just this summer, that 95% of advisors report being asked about ESG by their clients.
Linda: So, it is now. Huh, Mary? It is now.
Mary: Yeah, It is now. And yet last year when we did the survey, less than 24% of advisors felt comfortable talking about ESG. So, there's a mismatch. So if 95% are being asked, and you are not being asked, as an advisor, you're not being asked, there's a risk that your clients may be talking to someone else. So it really does behoove us all to increase our ESG fluency. Understand that spectrum of outcomes, and the product line along that spectrum is for everybody.
Linda: That's so interesting, because I thought, up even until recently, that it really was the younger generation of millennials, the Gen Zs, and women, of course. And now you're saying it's really proliferating. Do you know why? Why is this now? Why now?
Mary: Well, think about it. We've just lived through the biggest ESG decision of our lifetimes. And that is, the decision by governments and corporations to pull back on activity, on productivity during COVID. And they did this in order to support public health, to protect the health of employees, of citizens. That is an ESG decision. That's squarely in the S column, in the social column, because these are risks that have people on the other side of them.
Linda: Yeah. The pandemic is also part of what's going on here and making it seriously proliferate. Well, let's talk about performance now. ESG investors increasingly expect to do well while they're doing good, but isn't there a performance trade off?
Mary: A lot of people think that, and I'm here to say, No, there doesn't have to be. There's a lot of empirical evidence that supports the financial value of ESG factors within the investment equation. So, we actually often quote From Stockholder to the Stakeholder. And they looked at hundreds of studies on ESG and performance. And it shows that it's more than just a feel good factor. I'm going to quote from this study. 90% of reviewed studies show that sound ESG standards lower corporate cost of capital. And 88% show that solid ESG practices result in better operational performance. In all important market performance, 80% of the reviewed studies show that stock price performance is positively influenced by good responsibility practices. And so, I'll give you an example, a pretty simple example. Let's go, again, to the S column, the social column, the human column. If a company has poor employee relations, poor employment practices, they're going to have higher turnover. And it costs more to continuously hire and to refill positions that have been vacated by unhappy employees.
Mary: It costs to train these new employees. It's a pretty simplified example, but you can see how ESG, the social column, really can have an impact on operational performance and the long term operational and financial performance of a company. We also look at it here at Federated Hermes. We've done a lot of work on proving the financial value of ESG in the investment equation. Every two years, we take a look at how each individual factor contributes. And we look at the entire array of companies out there, and we give them a quantitative ESG score. And there's a positive impact from having good environmental performance, but it's not a statistically significant. But overall, we found that there is positive financial impact for having good ESG practices. And it's true for fixed income, as well.
Linda: I've seen that too, just as I've started to study this over the last several years. And of course, as our company has gotten very much involved in ESG investing and integration, that there is, like you said, evermore proof that you see that in the data. And it's no wonder why we integrate it into our work, because we're looking to provide excellent performance for our clients.
Mary: Yeah. Linda, I'd like to add one other thing. What else is driving interest in sustainable investing? If you look at sustainable strategies in the Morningstar universe, they're overrepresented.
Linda: Awesome. Awesome. Okay, Mary, finally, can you discuss how ESG can enhance a financial advisor's business?
Mary: Oh, yes. Yes, yes. Absolutely. This is the future. And if you want to future-proof your business, you've got to be future ready. So you've got to understand ESG, and have some fluency and be comfortable talking about it. MMI, the Money Management Institute, has done lots of work looking at the next generation of inheritors, and they found that most inheritors don't stay with the parents' financial advisor. But one way you can really connect with this generation is to talk about their values, to show interest beyond just the financial and more into the personal. What are their passions? And can we align a portfolio with the passions? Today, the good news is, yes, you can. So if you want to future-proof your business, you've got to be future ready with ESG fluency. And we're really happy to help professional advisors with our Responsible Investing Institute.
Linda: Oh, excellent. So much great stuff here, and we're running out of time. So for me, your most powerful takeaways, I guess, we won't even be talking ESG 10 years from now. It'll be ubiquitous. It will be everywhere. And the ESG, the millennial generation, really many beyond the millennial generation, but for the millennials, the opportunity of the greatest intergenerational wealth transfer of all time. Thank you, Mary. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes Here and Now Podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Here and Now episode. Plus, our other series, Amplified and Fundamentals for a global perspective on the issues, challenges, and trends shaping the investment landscape. I also encourage you to subscribe to insights, updates from our website, and follow us on LinkedIn and Twitter.
Views are as of October 22nd, 2021, and subject to change based on market conditions and other factors. This should not be viewed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. ESG investments may be viewed as sustainable, responsible, or socially conscious, among other names. ESG factors may be utilized and evaluated differently by different investment managers. It may mean different things to different people. Investing based in part on ESG factors carries the risk that under certain market conditions, the investment strategy may underperform strategies that do not utilize such factors. The application of responsible investment criteria may affect exposure to certain sectors or types of investments, and may impact relative investment performance, depending on whether such sectors or investments are in or out of favor in the market. An investment's ESG performance or an investment manager's assessment of such performance may change over time.
The successful application of ESG factors is dependent on an investment manager's skill in properly identifying and analyzing material ESG issues, and the suitability of ESG investments may change over time. ESG equity inflows and asset gathering statistics refer to the report from Bank of America Global Research. ESG matters global. If ESG was a bubble, it no longer is, 6/1/2021. Demographic statistics of investors interested in responsible investing refer to the report from Morgan Stanley Institute for Sustainable Investing. Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice, 9/11/2019. Financial value of ESG factor statistics refer to the research paper From the Stockholder to the Stakeholder, How Sustainability Can Drive Financial Outperformance, co-authored by the Smith School of Enterprise and the Environment at the University of Oxford and Arabesque Asset Management, 3/5/2015. Federated Advisory Services Company.
Tags Markets/Economy . Responsible Investing .

ESG investments may be viewed as “sustainable,” “responsible” or “socially conscious,” among other names. ESG factors may be utilized and evaluated differently by different investment managers and may mean different things to different people. Investing based in part on ESG factors carries the risk that, under certain market conditions, the investment strategy may underperform strategies that do not utilize such factors. The application of responsible investment criteria may affect exposure to certain sectors or types of investments and may impact relative investment performance depending on whether such sectors or investments are in or out of favor in the market. An investment’s ESG performance or an investment manager’s assessment of such performance may change over time. The successful application of ESG factors is dependent on an investment manager’s skill in properly identifying and analyzing material ESG issues, and the suitability of ESG investments may change over time. 

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

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