Growing interest in the impact of fossil fuels on the global climate often sparks questions from people about whether they can integrate their values around sustainability with their investment goals and, if so, how.
According to a global sustainable investment group that covers Australia, New Zealand and other developed nations, assets managed under 'responsible investment' strategies increased by 25% between 2014-16 to $US22.89 trillion.[1]
Responsible investment is defined by the UN as an approach that aims to incorporate investors' preferences around environmental, social and governance (ESG) factors into their investment portfolios.
Sustainability preferences are not restricted to greenhouse gas emissions. Many people also have concerns about land use and biodiversity, toxic spills, and operational waste management. Others want to exclude companies strongly associated with undesirable social issues such as tobacco, alcohol, gambling, pornography, child labour, factory farming, nuclear weapons, and cluster munitions and landmines.
The key question is how to do you express your preferences while maintaining sufficient diversification and your investment objectives?
A solution is to focus first on developing an investment methodology that emphasises the sources of higher expected returns while minimising turnover and trading costs. Once this framework is in place, we can get to work on the other part.
That second phase starts with evaluating companies on a broad array of sustainability measures across all industries.
Within each industry, the least sustainable companies are excluded, while the rest are overweighted or underweighted based on how well they rank among their industry peers. By using this scoring system, rather than an in-or-out screening process, we can preserve diversification while encouraging good behaviour.
With social screens, we can take more of a black-and-white approach. So companies that draw a significant proportion of their revenues from tobacco, gambling or one of the other proscribed activities can be excluded altogether.
Importantly, this process of screening and exclusions can be applied to fixed interest component of a portfolio as well as to the equity component. The principles and the approach are broadly the same.
The key point to take away is that investing well and sticking to your values around sustainability need not be incompatible concepts. But as always you have to take a systematic approach, observing the principles of diversification and targeting the sources of higher expected return.
Whoever said it's not easy being green?
For more information on sustainable investing or to discuss your financial and wealth management plan, do not hesitate to contact us at admin@warrhunt.com.au or on 0399350970.
[1] 2016 Global Sustainable Investment Review, Global Sustainable Investment Alliance.