Direct Indexing, ESG, and Ukraine

Those are the three things that bounced around in my head all weekend, coalescing into… a conclusion — personalized portfolios are the future of ESG.

Why Direct Indexing, ESG and Ukraine?

Direct Indexing because… it was far and away the #1 topic at the Money Management Institute Summit last week. Every wealth and SMA manager aspires to offer some form of direct index product to support personalization for tax optimization, ESG, and risk.

ESG because… while at the MMI I had conversations with two asset managers who told me similar stories — after spinning up ESG teams and funds and establishing track records, they’re now starting to unwind some of those products and de-emphasize ESG. The U.S. demand hasn’t materialized and they’re increasingly skeptical it ever will, and the performance isn’t compelling. ESG funds are missing the mark with investors.

Ukraine because… of obvious reasons. But within the context of the wealth management industry, the war in Ukraine is forcing some big shifts in ESG thinking and ratings:

The ESG profiles and practices of companies have not changed as a function of the war in Ukraine. The only thing changing is the sensibilities of ESG asset managers and data providers. News articles regarding this change in ESG ratings brought me to an important personal realization

ESG investing is tantamount to outsourcing your beliefs, politics, and morality.

So the primary selection criteria for an ESG manager should be assessing how well they align with your personal convictions in those areas — quite different than selecting a manager based on performance or other traditional measures and metrics.

Because there are many of us who always supported investments in defense and domestic energy production as worthy and laudable. And there are many of us who have always believed that ESG should be equally applied to developed western markets as well as developing and autocrat run markets, or not at all. We didn’t need Russia’s invasion of Ukraine to change our personal convictions and sense of morality on those things.

Which leads me to a big and obvious conclusion — ESG investing is best implemented through personalized portfolio construction that reflects the values and priorities of the individual investor. With portfolio personalization, ESG-minded investors no longer need to outsource their morality to an asset manager.