How can you invest well and help the planet at the same time?

By December 4, 2019Share investing

Sustainable investing

The bushfires in NSW and Queensland recently reinvigorated the conversation about global warming and whether the Australian government is doing enough to combat it. I’ll refrain from sharing my thoughts on this topic (I’m sure no one cares what I think about this anyway), but I thought it was timely to write a blog about sustainable investing. If you are concerned for the environment, this is a way of ‘putting your money where your mouth is’.

Sustainable investing grew by 35% between 2016 and 2018. It now accounts for over $70 trillion of assets globally.

What is sustainable investing?

Substantiable investing means that you only invest in companies that are combating climate change, are socially responsible and have good governance practices. In simple terms, its investing in businesses that are doing the right thing. And, maybe more importantly, not investing in the businesses that are doing the wrong thing.

Sustainable investing is often referred to as ESG investing. ESG stands for Environmental, Social and Governance:

  • Environmental relates mainly to climate change (greenhouse gas emissions) but also includes, resource depletion, waste disposal, pollution and deforestation.
  • Social relates to matters such as human rights, modern slavery, child labour, working conditions, and employee relations. It includes avoiding investing in companies that are involved in tobacco, adult entertainment, weapons, gambling and so on.
  • Governance relates to matters such as bribery and corruption, executive pay, board diversity and structure, political lobbying and donations, tax strategy.

The organisation Principals for Responsible Investment (PRI) was established in 2006 under auspices of United Nations to help its signatories (investment managers) better understand and effectively implement sustainable investing principals.

What impact can this have?

An ESG fund can have a massive impact by avoiding companies with high carbon dioxide (CO2) emissions, for example. There are two types of omissions to consider: (1) actual omissions and (2) potential omissions. Potential omissions mainly relate to mining companies. It is the reserve of raw materials (minerals or whatever they are mining) that they have identified that still is yet to be mined.

By eliminating high CO2 omitting companies, your portfolio can reduce actual omissions by over 70% globally (and over 60% in Australia). That is, an ESG portfolio omits over 70% less CO2 than its comparable index does (i.e. the whole market). And better still, it reduces potential omissions by over 99% (both globally and in Australia)!

An ESG portfolio means that you are not investing in companies that are doing the most harm to the environment.

Does ESG investing reduce diversification or increase investment risks?

A common concern is that if we filter out the companies that do not meet the EGS screens, does that mean we lack diversification or are under/over exposed to various sectors? The answer is no.

The table below compares the portfolio sector weightings (top 6 sectors only) for standard global investment fund versus an ESG product. As you can see, there are small differences, but the allocation has not been materially skewed away from or towards any sectors.

sustainable investing

The standard global fund invests in 6,058 companies, so it’s very well diversified. The EGS fund invests in 1,562 companies which is substantially fewer than the standard product, but still very well diversified.

The ESG option has a slightly higher amount of portfolio concentration. In the standard product, the top 10 companies account for 9% of the overall fund. Whereas with the ESG option, the top 10 companies account for 15% of the total fund. Again, this does not substantially alter investment risks in my opinion.

What is the impact on investment returns?

Sustainable investing products are relatively new and not many have a long history of returns yet, particularly index style products. However, a ruled-based fund manager that we use, Dimensional established its product in 2016. Its investment return in the 3 years to October 2019 was 12.64% p.a. this compares favourably with its standard (non-EGS) product which has returned 10.27% over the same period. So, in this case, ESG returns have been higher.

In another example, Australia’s’ largest industry super fund (AustralianSuper) has had a mixed investment option called “Socially Aware” and it has returned 9.67% p.a. in the 10 years ended 30 June 2019. This is reasonable comparable to its Balanced option which returned 9.76% p.a. over the same period and its asset allocation is comparable. Unfortunately, AustralianSuper does not publish any information on diversification or concentration so it’s impossible to assess the portfolio’s risk.

In summary, it is my view that it is reasonable to assume that you may not forgo any material investment returns by choosing to invest sustainably. That said, it is important to maintain a diverse and considered asset allocation and used a broad spectrum of investment methodologies whilst, at the same time, maintain ESG compliance. Doing both of these things at the same time is very important.

How can you invest sustainably?

Just like with most things in life, whether you invest sustainable or not doesn’t have to be an all-or-nothing decision. You can gradually start to tilt your investments (including your superannuation) towards sustainable investments. Or, of course, you can switch to 100% sustainability tomorrow. If this is of interest, you should speak with your independent financial advisor and/or superannuation fund to find out more.

Or, of course, speak to us as we can combine our evidenced-based, low-cost investment strategies with a sustainability overlay. This will ensure you adopt the most successful investment methodologies and structure whilst still ensuring your investments reflect your personal values.