By Louis Williams, Head of Psychology & Behavioural Insights

Advice firms aim to optimise their clients’ investment returns. But the potential impact sustainable investing can have can be misjudged, alongside the importance clients place on returns and their sustainability preferences.

As sustainable investing, as a subject, considers managing risk, doing well by doing good, reduced financial opportunities, potential for lower returns, and emotional and ethical motivations, conversations pivot on a clear understanding of someone’s goals.

Designing a measure to effectively understand clients’ sustainability preferences, covering such a broad acknowledged area is therefore crucial.

How are a client’s sustainability preferences currently captured?

To date, emphasis has been placed on understanding the impact companies have concerning environmental, social and governance [ESG] issues. However, few advances have been made to create a true process where a client’s sustainability preferences are accurately captured.

Multiple choice questions, using mock scenarios, are one path being explored, allowing a client to select preferred investments after being provided with information about their sustainability and returns. There are advantages to this approach as it removes a very direct line of questioning which can potentially invite a respondent’s biases into the equation. However, such an approach also has disadvantages.

First, hypothetical scenarios are not indicative of decisions made in reality. Second, the fund universe and dynamics within an investment portfolio reach far beyond what can be encompassed by a simple multiple-choice task.

Third, it is incorrect arguably to situate ‘sustainability’ at one end of a spectrum and ‘investment returns’ at the other, when sustainable investments can generate greater returns.

Fourth, multiple choice questions and mock scenarios demand a client has prior financial and mathematical knowledge, which they may not. Finally, fifth, a client’s responses may be distorted in a mock scenario – for instance – involving a company they have a view on.

Why adopt a psychometric questionnaire here?

It is not useful to view sustainable investing as simply a box ticking exercise. Nor is it helpful to overwhelm a client with information available.

To understand a client’s preferences the key is real engagement, so their preferences can be captured and also the implications of their choices can be discussed. Sustainable investing preferences, as we have noted, can be complex, encompassing a broad church of relevant factors. Therefore, a suitable step in your firm’s process is required to serve as a trusted foundation for a conversation with a client.

Psychometrics combines thinking from the schools of psychology and statistics. A psychometric questionnaire therefore is created to cut through the noise of, as we have noted, direct questioning to effectively understand how someone might feel and act both in the short and long-term.

While there is no history or track record of psychometric ESG questionnaires, at Dynamic Planner, we are fortunate that our team have the experience of successfully creating the most popular and most proven risk profiling questionnaire in the UK, supporting more than one million clients of advice firms since 2013.

At the beginning of 2018, we launched in Dynamic Planner a new psychometric attitude to risk questionnaire, which again has proved hugely popular with advice firms and, in the last 12 months, during the Covid-19 crisis, has stood up robustly when continuing to measure a client’s attitudes to investment risk.

We have followed a similar formula now to build and release a psychometric questionnaire to capture a client’s sustainable investing preferences, ensuring it is reliable, valid and that it measures what it intends to.

How did we build our sustainability questionnaire?

There are a number of key things to consider when designing a psychometric questionnaire. They are:

  1. Avoid complex terminology or jargon
  2. No financial knowledge needed for completion
  3. Avoid repetition or redundant questions
  4. Capture multiple dimensions of what is being measured
  5. Avoid double-barrelled or ambiguous questions
  6. Employ an appropriate number of questions
  7. Choose an appropriate question order

That all said, even when questions are clear and well supported by academic thinking, a questionnaire can still fail to capture what it intends to. Clear, statistical steps must be taken to validate a questionnaire.

At Dynamic Planner, we tested our psychometric sustainability questionnaire on more than 1,000 UK investors, alongside taking significant steps before reaching a robust, final version. We also consulted with focus groups of advisers.

What does our questionnaire measure?

#1 Psychological distance
People are more likely to take greater risk regarding decisions which impact far in the future. If we consider the example of climate change, acting now may feel unattractive given that the promise of reward appears distant and uncertain.
An individual may acknowledge the importance of sustainable investing, but when considering benefits are largely for future generations, this can impact their decision in the short-term. Psychological distance measures this balance.

#2 Personal values
It can be assumed that a client’s sole desire is to maximise their wealth. However, they can also be motivated to promote social change, consistent with personal values and therefore be willing to accept lower returns.
It is important to understand an individual’s views on controversial or unsustainable areas of investment and how far their portfolio should reflect their values and beliefs.

#3 Emotional benefit
It is important to measure the emotional benefits of investing. People can benefit emotionally when they believe they have acted responsibly through their investments and can feel compensated if they receive lower returns, as a result.
Emotions are important when making financial decisions and taking risk. People who are positive can be more risk seeking, while decisions around sustainable investing can, as we have noted, evoke positive emotions. It is therefore important to understand a client’s positive or negative emotions towards how companies manage ESG risks.

#4 Positive impact
We know a proportion of investors express a desire to do good with their investments, producing social and / or environmental benefits. This extends beyond a company simply monitoring or managing ESG risks. Such individuals are socially motivated.
They may be prepared to accept lower returns in order to achieve their goals, whether it is their own investments directly having a positive impact, or whether they are contributing more broadly to change in investing. It is important to identify how a client seeks to actively engage with companies to generate positive and measurable social and environmental impact, alongside financial returns.

#5 Financial considerations
Although investors may display preferences for sustainable investing, there are trade-offs that they should be aware of. Studies have shown that ESG investments can produce at least competitive returns. Nevertheless, it is important to understand how a client prioritises investment opportunities and financial returns in relation to sustainability preferences.

How can Dynamic Planner help your firm regarding sustainable investing? Find out at one of three webinars from 8-10 June