There are two reasons advisors and investors consider ESG investing, but thus far only one is grounded in reality, according to Envestnet’s Dana D’Auria.

D’Auria, co-CIO at Envestnet PMC, has noticed that advisors are increasingly pitching environmental, social responsibility and corporate governance-oriented (ESG) portfolios and investments on their potential to offer excess financial returns, or alpha, or market returns with less risk, a “smart” or “strategic” beta.

But thus far the evidence that  ESG portfolios can offer alpha or a better form of beta remains unproven, making a more traditional moral rationale for ESG investing the safer argument from advisors, said D’Auria.

“There are thousands of papers on ESG, several meta-studies and even studies of the meta-studies trying to determine whether there may be some added financial benefit to ESG investing,” said D’Auria. “At the same time, we’ve seen several studies into the non-ESG stocks, the so-called sin stocks, that show they tend to outperform. So the idea that there’s a true alpha thesis for ESG is still in doubt, though there is some encouraging research emerging.”

Among such research are papers determining that environmentally sound companies have fewer regulatory and legal risks, that diversity on boards and in the C-suite can lead to better financial performance, and that socially responsible companies are less prone to costly boycotts and other reputational risks.

D’Auria also points out that the smart- and strategic-beta communities already have  a proxy for good corporate governance in the quality factor – so it’s difficult to determine whether any form of good governance is delivering excess or better risk-adjusted returns beyond the benefits of investing  in securities with quality factor characteristics.

“A lot of people think there won’t even be ESG investing in five to 10 years,” said D’Auria. “The theory is that we will reach equilibrium for the expectations of regulators and investors, these ESG externalities will be incorporated into securities prices by analysts, and any long-run beta benefits to ESG investing will dissipate. To have long-run beta, you have to have a reason to believe it will continue to be underpriced like small companies or value stocks, and I don’t know why that would be the case with ESG.”

But what about excess returns in the form of alpha from ESG investing? While D’Auria thinks there could be a short-term alpha thesis in ESG investing because of the rapid growth in interest in this kind of investing on the part of asset managers, advisors and end investors, that interest may end up outpacing the actual returns and cash flows of ESG-oriented companies. The result could be a downturn in the pricing for ESG securities, erasing any potential alpha benefits from investing in them.

The best reason for advisors to pivot towards ESG investing is not the promise of offering alpha or beta to clients, but because certain clients demand that their portfolios be brought in line with moral or political beliefs, said D’Auria.

ESG’s rise in prevalence has caught some advisors flat-footed, she said, as investors and asset managers respond to the potential for additional regulation, penalties for pollution and other corporate behaviors and shifting consumer interests.

“Because the client is being driven by these concerns, we’re moving past the point where client interest is the only reason that the advisor has to engage,  but the danger is that there are a lot of stories out there that say aligning portfolios with values won’t cost you money or can lead to better returns, and that’s not exactly the case,” said D’Auria. “ESG conversations with clients have to be nuanced enough to capture that, and we have to be realistic depending on the products.”

Thus, the conversations around clients should be both proactive and responsive on the part of advisors: Discover the client’s ESG interests and offer them a plan, with investments, oriented towards those interests, leaving aside discussions of risk-adjusted returns and potential alpha.

Envestnet offers ESG products across its asset management platform, and provides due diligence, tagging and information on asset managers who are qualified in the ESG space. The company also provides education materials for advisors and their clients on impact investing and different approaches to socially responsible and positive-screening ESG investing.

Envestnet is also developing more robust tools around ESG portfolio reporting, said D’Auria.

“The future of investment reports is going to look much closer to what is currently called an ESG impact performance,” said D’Auria. “Advisors will be expected to tell clients not just about their return and standard deviation, but also what impacts were made on their ESG interests versus a benchmark – how many fewer barrels of oil did they use, for example.”

D’Auria acknowledged that advisors can’t be expected to master all of the different possibilities for ESG-oriented investing, which are already moving beyond bespoke portfolios aimed at climate change or diversity impacts and index funds excluding “sin” stocks, impact funds that work directly with companies to effect change, or weighting companies with ESG bona fides more heavily.

Thus, technology like Envestnet’s platforms has a role to play in progressing ESG investing, from assessing the client’s interests, matching those interests to the right investment or product, to reporting the specific impacts that their environmental and socially responsible financial choices are having on the world and the communities around them.

“Technology has to give advisors the ability to leverage more comprehensive ESG strategies without having to become experts themselves,” she said.