by Andrew Dines
Director & Chartered Financial Planner
At Glastonbury 2019 David Attenborough gave a passionate speech about the impact humans and our behaviours are having on the sustainability of our planet. This got me thinking about the growing interest from clients in responsible investing and questions we are asked about whether individuals can integrate their values around sustainability. For instance, how can they reduce their portfolio’s environmental footprint while maintaining sound investment principles and achieving their investment objectives?
As citizens, individuals can express their political preferences around sustainability through the ballot box. As investors, they also can express their preferences through investing in global capital markets. One key question these investors face is how to do this without compromising their desired investment outcomes.
Sustainability preferences are not generally restricted to one area and many investors have concerns about fossil fuels, land use and biodiversity, toxic spills, operational waste and water management, among many other issues. Thus, it is a challenge to achieve the dual goal of efficiently considering an individual’s personal preferences while building investment solutions that help meet investors’ financial goals. One way to approach this challenge is to focus first on developing an investment methodology that emphasises what research indicates are reliable sources of higher expected returns while also aiming to minimise unnecessary turnover and trading costs. For instance, taking a broad market approach with biases towards small, undervalued and profitable companies is an option for clients who wish to adopt an evidenced based approach to investing that doesn’t rely on speculation.
Next, investors can evaluate those companies being considered for investment using a focused set of environmental issues that reflect their primary concerns. By using a holistic scoring system, rather than a completely binary “in” or “out” screening process, investors may be able to preserve diversification while recognising those companies with positive environmental profiles.
This involves looking at companies across the entirety of a portfolio and within individual sectors with the goal of incorporating sustainability preferences while also maintaining the characteristics of the original evidenced based strategy.
For example, if one is trying to reduce a portfolio’s greenhouse gas emissions and potential emissions from fossil fuel reserves, the worst offenders across all industries may first be excluded from the portfolio altogether. By taking an across-industry comparison of this nature provides an efficient way to significantly reduce the aggregate greenhouse gas emissions within a portfolio with a minimal reduction in diversification.
Next, companies may also be rated on sustainability considerations within each industry. This added level of scrutiny is recognition that, in the real economy, capital markets and the supply chain are highly interconnected. For example, a retail company may consume electricity from a utility company and transportation services from a trucking company, both of which are consumers of fuel from an energy company. Comparing companies within sectors recognises this interconnectedness and can be used to overweight the most sustainable companies within a given industry. This could include retail companies that improve the energy efficiency of their facilities, utilities that produce electricity using solar or wind power, trucking companies that improve the fuel efficiency of their fleets or use alternative-fuel vehicles or energy companies that increase efficiency, reduce waste and improve their overall environmental footprint. Conversely, companies with poor environmental sustainability ratings relative to industry peers may receive a lesser weight or may be excluded.
The key takeaway for investors is that investing well and incorporating values around sustainability need not be mutually exclusive. By starting with a robust investment framework, then overlaying the considerations of sustainability-minded investors, allows for a cost-effective approach that provides investors the ability to pursue their sustainability goals without compromising on investment principles or accepting lower expected returns.