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Protecting Our Tomorrow - Sustainability, ESG, and Direct Indexing

By Barrett Ayers, President


It is impossible to talk about 2022 financial trends without focusing on the rise of ESG investing. According to a recent Bloomberg study, ESG assets are on track to hit $53 trillion — one-third of global assets under management (AUM) — by 2025. In other words, the increased emphasis on environmental, social, and governance (ESG) issues has resulted in a significant reallocation of investor capital in recent years, and that trend is expected to continue.

Activism Through Investments & ESG

ESG reporting is on the rise! According to the Governance & Accountability Institute, 92% of S&P 500 companies produced a corporate sustainability report in 2021 compared to only 20% in 2011. Standardization of reporting is also improving and investors are increasingly applying these factors as part of their analysis process. ESG factors include but are not limited to carbon emissions, gender and diversity, bribery and corruption, and data privacy.

Let’s start with the first argument in favor of ESG: as global citizens, investors have a responsibility to back companies and projects that will have positive long-term effects on the planet and its occupants. As a result, ESG investing is considered an ethical or value-oriented approach to financial management, with a strong focus on issues such as energy sustainability and human rights violations. Many investors have taken advantage of ESG metrics to actively oppose big oil and non-renewable energy sources in an effort to curb climate change.

Beyond ethics, many investors are applying ESG-related factors to their analysis process because they believe companies with high ESG scores will fare better financially. According to a recent Harvard study, investors increasingly consider ESG criteria to be closely linked to a company’s competitive strength and future financial performance. A Morgan Stanley study suggests that millennial investors are nearly twice as likely to invest in companies and funds that meet their environmental and social values than the rest of the individual investor population, indicating that even those that are not drawn to ESG for moral reasons stand to benefit financially from following the trend.

The Direct Indexing Solution

If ESG investing is the future, advisors clearly need to adapt. But there’s a catch. Advisors have been struggling for decades to construct an investment plan for their clients that is consistent with their personal preferences without compromising on performance or time. In a prior blog, we covered why exclusionary investing and ESG thematic managers are imperfect solutions to this challenge, to say the least.

Enter Direct Indexing, arguably one of the best ways to incorporate client preferences into an investment portfolio without compromising on performance objectives. Direct Indexing gives clients broad exposure to an asset class, such as large-cap equities. But rather than buy a mutual fund or exchange-traded fund, investors own the individual stocks that comprise an index. The customization comes in when advisors tweak which index components they buy — or don’t buy — and in what proportions. With Direct Indexing, you can apply the appropriate ESG modules to an S&P 500 index in order to adhere to your clients’ values while aligning with the index’s performance.

To add a cherry on top, Adhesion Wealth’s indexing strategies offer the potential to experience better after-tax returns because investors own the stocks directly, so they can optimize a suite of tax-managed trading services that they normally wouldn't be able to with ETFs or mutual funds. With our single platform interface, advisors can quickly and easily reduce the trading and rebalancing burden, and possibly reduce tax expenses.

Many advisors have already begun to leverage Direct Indexes to offer their clients a personalized investment option that still provides index-like returns. With sustainable investing only expected to continue growing in the coming years, it’s time to catch the wave, or risk falling behind.

Want to learn more about Direct Indexes? Request a consultation with Adhesion Wealth today!

By Barrett Ayers, President