May 29, 2021
A closer look into "Sustainable Investing" and how it impacts portfolio management.
I think everyone can agree that the main purpose of investing is to generate positive returns to grow investment assets. I have yet to meet someone that told me they invest to lose money, even if they invest in highly speculative securities. Beyond the numbers though, more investors are also looking to align investments with their values. This has led to a growing trend of “sustainable investing”, an umbrella term which includes Environmental, Social and Governance (ESG) investing and Socially Responsible Investing (SRI).
Although both terms are often used interchangeably, there is a difference between ESG and SRI investing. ESG refers to environmental, social and governance issues that an investor may consider when making an investment. Here are a few examples of each factor:
Environmental considerations include climate change and carbon emissions, air and water pollution, waste management, water scarcity.
Social considerations include data protection and privacy, gender and diversity, employee engagement, labor standards.
Governance considerations include board composition, executive compensation, bribery and corruption, whistleblower policies.
When portfolio managers include ESG in their investment decision process, they typically start by identifying compelling investment possibilities based on a traditional set of financial criteria. After all, the vast majority want profitable investments. Then, they will apply an ESG lens to determine which of these pre-selected investment options meet their ESG standards. By using this approach, it is possible to invest successfully and sustainably. It also allows proper diversification since no sector is automatically excluded.
The exclusion of industries from the basket of investment possibilities is a common misconception of ESG investing. For example, some may believe that oil producers will be excluded from a portfolio managed along the principles of ESG because of their environmental record. In fact, the portfolio manager will look at what these companies are doing to address ESG issues before deciding if they are a good fit for the portfolio.
This is the main difference between ESG and SRI. The latter will usually use negative screening methods to exclude some sectors or sub-sectors from the portfolio. For many years, many portfolio managers have had an SRI policy that excludes investments in tobacco, adult entertainment, military weapons and other industries that might be viewed as “less than ideal” from a moral perspective. SRI has broadened its scope, from excluding certain types of investments based on moral values to excluding industries that have a negative impact on ESG factors. One thing to keep in mind with this approach to investing is the concentration risk. The more industries are excluded from your portfolio, the less diversified it will be, which could increase its volatility.
Sustainable investing is not just a fad that will go away. You just have to look at the changes many companies are making from the non-financial information they are now disclosing related to ESG factors to the actions taken to address environmental, social and governance considerations. Just here in Canada, in the Energy and Materials sectors, you are seeing companies reducing GHG emissions, taking initiatives to reduce their carbon footprint, developing carbon capture technology and moving to renewable sources of energy to power their operations. Companies are making these changes in response to investors’ demands.
There are plenty of sustainable investment options out there, but they are not all created equal. Investors interested in sustainable investing should have the discussion with their advisor or portfolio manager to understand how it is, or can be, incorporated in their portfolio, all the while maintaining a profitable investment strategy.
Author:
Marc André Castonguay, CFP®, CIM® is Director of Financial Planning with Louisbourg Investments. Comments or questions may be submitted to him at marcandre.castonguay@louisbourg.net.
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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.