Ethically minded investors are growing more skeptical of ESG investing, wondering whether it actually furthers environmental or social justice aims. At the same time, demand for ethical investing is only going to increase as progressive millennials and Gen Zers accrue more financial assets, often by inheriting that money from their conservative parents.
If the long-anticipated SEC rules on ESG do not satisfy them, a prospect that seems increasingly likely as financial services industry groups push back on proposed disclosure rules, we should expect to see an ever-increasing appetite for alternate investment approaches.
Even if the final SEC rules are strong, ESG can never completely starve industries like fossil fuels. As companies and funds dump their coal mines to bump up their ESG scores, for example, those mines just get bought up by private equity firms, resulting in money moving around but no fundamental changes. Consider: more than a third of all assets under management are now in socially responsible or ESG funds, yet global emissions continue to increase.
As Gen Z and millennials have more money to invest, I expect to see five trends accelerate as alternatives to traditional ESG investing:
Greater availability of non-market investments.
As more investors conclude that publicly traded corporations can never be socially responsible, we will see growth of funds focused on "transformative investing," an approach that seeks to build a more equitable economy that works for all, often called a "solidarity economy." Expect to see a proliferation of non-market funds that provide loans to community-level businesses, especially in disinvested and marginalized communities of color, and provide returns on those loans to investors, albeit at a lower rate than market-based funds, perhaps modeled after current funds like the Ujima Capital Fund in Boston and the nationwide Seed Commons fund network.
More direct indexing options.
Though direct indexing was created to let investors maximize their profits, it has enormous potential as a tool for ethical investing, allowing individuals to purchase a broad index and then subtract stocks of companies that do not meet their own values-based standards.
Most of the large investment firms have recently begun to offer direct indexing to individual clients, and we should expect this offering to become accessible to a broader range of investors.
