Sustainability. Social responsibility. Ethical impact.
Buzzwords like those have become increasingly common in all sectors of policy and the news. Individuals love the ideas that these terms represent, and businesses are wisely capitalizing on that positive sentiment.
In the investment realm, the focus on socially responsible, “green,” ethical approaches to growing and managing wealth is generally known as ESG investing. Those three letters stand for “environmental, social and governance.”
“Environmental” represents the impact on natural resources. “Social” indicates “how a company manages relationships with its employees, suppliers, customers and the communities where it operates.” And “governance” concerns all factors contributing to and impacting a company’s executive structure, salaries, audits, shareholder issues, etc.
Millennials and Younger Investors Find ESG Investing Particularly Attractive
Many industries target millennials, the group of young people born in the range between the early 1980s and the early 2000s. The financial investment industry is no different, and for good reason -- thanks to their parents’ wealth, millennial investors due to inherit $30 trillion of potential assets from the baby boomers.
For this subset of the population, sound investment strategies aren’t enough to win investor loyalty. Millennials value things like sustainability, clean energy and social impact investing strategies very highly.
It’s not just about their beliefs. Millennials are exposed to positive media coverage and celebrity endorsements about ESG investing. Pop culture giants like Bono and Bill Gates champion ESG investing openly, lending it greater credibility and popularity. It’s one of the top trends in Wealth Management.
Millennials are one of the reasons why ESG investing has grown so much in recent years.
The millennial taste for ESG investing coincides with a rise in financial management startups. Thanks to their memories of the 2008-’09 banking crisis, millennials tend to be wary of legacy money management firms. Robo-advisors like Acorns, Betterment and Wealthfront offer digital-first investment products with low fees and slick digital interfaces. Features like those are unusually attractive to young investors as compared to their generational predecessors.
And speaking of the baby boomers, members of that group are retiring at a rate of 10,000 per day. That means there are 71 boomers for every 1 financial advisor. With numbers like those, it’s no wonder that there’s a boom in investment tech innovation lately.
ESG Investing Startups Are Agile and Innovative
Traditional wealth management is an industry with high barriers to entry. AUM (assets under management) distribution tends to be highly skewed.
Enter ESG investing startups. The very presence of these disruptors has sent shock waves across the entire financial management industry. Some of the bright spots: “lower account minimums, lower fees, rock-bottom commissions, target audience expansion, automated rebalancing, and, in general, a bet on advanced technology + an expert in wealth management.”
The landscape is becoming such that legacy investors who fail to incorporate startup-style ESG investment technology not only find themselves fighting an uphill battle as far as popularity is concerned -- they’re often not able to adequately keep up with the volume of new information and knowledge available, as well as the unprecedented speed with which the market moves and reacts.
Without such innovations as AI, automation and machine intervention, investment firms run the risk of failing to remain competitive. Alle Group calls this condition “information overload” -- a complete inundation of data that has surpassed the “peak human capacity” to sift through it. Indeed, according to Deutsch Bank’s research group, “the amount of data reported to the SEC has increased five-fold since the financial crisis.”
Quarterly SEC filings that were formerly about 10,000 words long in the 1990s are now, on average, twice that length; annual filings have ballooned to about 50,000 words. It’s simply impossible for even the most diligent human investment advisor with superb speed-reading skills to read and absorb the new volume of words (and the associated data therein). Thankfully, sophisticated bots, web crawlers and artificial intelligence tools are capable of digesting huge amounts of information in seconds and offering up the highlights.
Technology Hasn’t Replaced Humans in ESG Investing -- And That Day May Never Arrive
As in many industries, ESG investment technology allows for stunning advancements in the ease, speed and capabilities of modern companies. But there’s a limit to this convenience: Observe the Hathaway effect -- the phenomenon whereby whenever movies starring the actress Anne Hathaway are released, share prices of Warren Buffett’s Berkshire Hathaway rise.
It’s the result of a glut of machine-automated algorithms scanning the headlines, trying to act in real time on the masses of new information. This phenomenon clearly demonstrates the shortcoming of tech in ESG -- or at least, the clear mandate for smart guidance by intelligent humans.
Blockchain Can Be Used to Enhance ESG Risk Management
Cryptocurrency and blockchain are two hot topics that have exploded in popularity within the past year. Both have exciting applications with regards to ESG investing. The ESG and corporate governance research group Sustainalytics has identified three key areas in which blockchain “can potentially be used as a tool to enhance ESG risk management”: supply chain transparency, data protection and energy efficiency.
Corporate behemoths IBM and Walmart have teamed up to test the potential of blockchain to track and enhance supply chain transparency. The key lies in the fact that blockchain is a digital ledger, so data about the history of a given product can be immutably embedded during its production. Blockchain can be used in data protection, to prevent data corruption and protect against cyberattacks. And for energy efficiency, the technology can be used to capture all transactions and ensure their validity in a blockchain-facilitated microgrid.
Cryptocurrency and blockchain are by no means a silver bullet, however: The relative novelty of these innovations means that there are certain regulatory and operational kinks to work out. For example, the fact that blockchain data cannot be modified may mean that its use does not conform to the European Union’s 2014 “right to be forgotten” rule.
Technology and ESG Investing Go Hand-in-Hand -- With a Few Caveats
Technology and innovation are an important part of modern ESG investing. Startups are leading the way in implementing exciting new tools and features that help this branch of investment appeal to the large and growing segment of young investors.
In addition to technologies like AI, robots and big data sorting -- which obviously reduce the amount of time and manpower needed to sift through the news events and relevant facts required to make informed ESG investment decisions -- there are even more exciting applications that only become apparent as new methods are tested to replace the traditional wealth management strategies.
The “cutting edge” nature of this marriage between tech and ESG investing makes the union both fruitful and interesting. However, it’s important to be appropriately circumspect about the new and exciting ways that financial investment firms -- both startups and legacy -- are utilizing this technology and its possibilities.