Millennials are starting to pop up more and more in financial news because the oldest in that generation (born in the early 1980s) are entering their prime, wealth-building years. This means they are starting to spend more of their savings on weddings, houses, babies and retirement. (Full disclosure: I’m a millennial!)

The entry of millennials into this stage of life presents a lucrative opportunity for financial advisors. Instead of starting with a large asset base that has distributions around the corner (baby boomers), advisors can start with a smaller base—but one that continuously grows. There are some hurdles to overcome, however. Millennials have different mindsets from prior generations, and advisors need to consider these if they are to fully maximize the potential millennials represent.

Evolution Of Financial Products: ETFs

Whether millennials are seen as tech-savvy or tech-dependent, it’s obvious they have embraced technology with open arms (supercomputers, formerly known as phones, are within arm’s reach at all times). This means they can connect with and appreciate the same type of innovation happening in the financial industry through the creation of exchange traded funds (ETFs). These funds utilize the top qualities of stocks (more options to get targeted exposures, intra-day trading) and mutual funds (well-diversified, track a theme/index) to come up with a best-of-both-worlds financial innovation.

Millennials are generally also skeptical and cost-sensitive in nature, making ETFs an ideal option.

1. ETFs are completely transparent, index-based products, meaning investors will always know what they are holding and can be confident in more consistent exposures.

2. They cost much less than traditional mutual funds (according to research my firm, CLS Investments, has done, the simple average cost of an ETF is 0.56 percent compared to a mutual fund at 1.15 percent). This allows for lower-cost asset management—one reason for the great success of robo-advisors, which provide easy-to-set-up online retirement accounts with reduced management fees.

3. Many brokerage custodians, such as Schwab, TD Ameritrade and Fidelity, have created lineups of No-Transaction-Fee (NTF) ETFs on their platforms so investors can trade ETFs without paying per-trade commissions, as they would with stocks.

A recent BlackRock study found millennials are currently invested in more ETFs than the average investor (33 percent vs. 25 percent) and are more likely to invest in ETFs over the next 12 months (70 percent vs. 52 percent).

The popularity of ETFs can be seen in their tremendous asset growth. According to Morningstar Direct, a couple of huge milestones were recently hit: Total assets crossed $3 trillion and the number of listed ETFs in the U.S. is now more than 2,000.  Although the ETF market has grown rapidly over the last decade, it is nowhere near the $17 trillion mutual fund market, so there is plenty of room to run. This type of growth is consistent with other groundbreaking technologies, such as the cell phone, which take time to get everyone on board.

Evolution Of Values: ESG

Compared to prior generations, millennials tend to think more about social responsibility in areas such as workplace equality and climate change, and they are also more globally minded. Baby boomers were also concerned about social issues, but millennials are willing to use their money more generously to promote social causes. A Morgan Stanley study found millennials are the most interested in sustainable investing (84 percent vs. total average of 71 percent) and are nearly twice as likely to buy investments targeting specific social or environmental outcomes (22 percent vs. total average of 12 percent).

While millennials may be interested in sustainable investing, the study found approximately 54 percent believe sustainability and financial gains are trade-offs. But there has been an evolution within values-based investing that may not be fully realized. Let’s quickly review socially responsible investing (SRI) vs. environmental, social, and governance (ESG):

• SRI is the “old school” or “traditional” values-based investing strategy. It is referred to as exclusionary screening because the methodology excludes stocks from an index. These are typically “sin stocks,” such as those in the tobacco, alcohol and firearms industries.

• ESG is the “new school” values-based investing strategy. It is referred to as inclusionary screening because the methodology includes companies that exhibit favorable traits, including:

• Environmental — reducing fossil footprint, managing resources wisely, etc.

• Social — respecting human rights and culture, promoting workplace equality and product safety, etc.

• Governance — stewardship for shareholders, being transparent and accountable, etc.

While SRI is associated with paying more to screen stocks without offering any particular benefit to potential returns, ESG acts more like a risk factor with proven historic returns. Specifically, the ESG strategy acts as a component of the quality factor. It includes more stable and profitable companies, which should perform better over time and are better able to weather market downturns and avoid lawsuits from financial and environmental wrongdoing.

Similar to ETFs, the popularity of ESG can be seen in the growth in assets. There has been consistent growth over the last decade and particularly strong 33 percent growth since 2014, according to The Forum of Sustainable and Responsible Investment.

Evolution Of Risk Management

Over their relatively short lives, millennials have experienced two major bear markets: the tech bubble of the late 1990s and the financial crisis of 2008. And the latter happened just as many millennials were starting their careers, which meant they bought into retirement accounts at the market peak. This has made them cautious about selecting asset classes and prompted them to avoid buy-and-hold strategies, which worked well for baby boomers. So millennials may be more inclined to embrace active allocation approaches that focus on risk management.

Traditional stock-to-bond management is a thing of the past. The first step in risk management evolution is risk measurement—within asset classes and for individual securities. After all, the risk inherent in large-cap stocks differs from that of small-cap stocks, as the risk in corporate bonds differs from U.S. Treasuries. Once risk is measured, it can be targeted in a way that keeps the investor feeling comfortable with the portfolio. This will ensure expectations are met and provide a smoother and more diversified ride over time.

The second step is factor modeling. It is important to understand whether a portfolio has any unintended risk exposures, and factor risk management can help. It often involves complex and expensive analytical tools that run in-depth quantitative analyses, but these tools, and the knowledge of how to use them, are quite necessary. While stock picking may seem simple, investors need to understand how each security interacts with every other security in a portfolio. This is not something the human brain can do on the fly. A portfolio needs to be consistently analyzed to ensure risk exposures do not change over time and new trades do not disrupt favored factors.

A focus on risk management will help millennials feel confident about their investments, letting them know their portfolios are managed to their comfort levels, regardless of changes in financial markets. It also allows for active asset allocation to potentially boost returns, while staying within risk targets.

Millennials are quickly becoming the target market for financial advice, but advisors need a different approach to match their investment management needs. A precise focus on advancements and evolution within financial products, values-based investing and risk management are the keys to impressing millennial investors.

Kostya Etus, CFA, is a portfolio manager for CLS Investments.