Artful Trader

How to create a responsible investment portfolio

At a time when multination corporations are facing an unprecedented amount of environmental, social and political pressures related to corporate governance, responsible investors, and the global investment community at large, is taking proactive steps to ensure that investors can align their values and principles with their portfolios.

A responsible investor is determining investment positions on their ability to make returns from environmentally and socially responsible initiatives, in other words, ‘impact investing’; it’s a philosophy that’s commanded wide-scale popularity and adoption in recent years.

Investments in global assets aimed at having a positive impact hit an estimated $502bn in 2018, according to a report in June by the Global Impact Investor Network, sponsored by US government agency USAID. It found that over 90% of respondents reported performance either in line with or exceeding their impact and financial expectations.

$502billion

Estimated investments in global assets aimed to have a positive impact

  

What had started as a movement to draw attention to social and environmental issues in the 1960s has expanded into other prominent areas, from promoting the rights of women and minorities to boycotting sectors such as weapons and tobacco. This idea of the ‘responsible investor’ has now reached the mainstream.

“It is more apparent today than ever before that we, collectively, need to address the world’s pressing sustainability challenges,” Therese Niklasson, global head of ESG at Investec, tells Opto. “Extreme weather events, water scarcity, forest fires, severe poverty, unsustainable consumption and inequality are just some of the many issues that have hit the headlines over recent years.”

“This greater awareness has prompted a broad audience to think about how they can contribute to combatting these issues and has driven an increased client demand for impact investing products,” she explains.

Since the growth trend began in 2015, more than 133 socially responsible investment funds have been launched in the US while the total number of sustainable equity funds in 2018 increased by 50% year-on-year to a record 351; many even outperformed the downturn in the market last December, according to a Morningstar report.

“It is more apparent today than ever before that we, collectively, need to address the world’s pressing sustainability challenges” - Investec global head of ESG Therese Niklasson

 

Success in ESG ETFs

In terms of performance, environmental, social and corporate governance (ESG) funds are very competitive. For example, the UBS MSCI ACWI Socially Responsible ETF’s sustainability rating is better than 96% of its peers. The fund also outperformed 80% of the 2,000 or so large-cap funds on Morningstar.

For traders, there is an abundance of ESG ETFs to look at when trying to assess the social impact of an individual stock. Examples include the ESG MSCI USA Leaders, MSCI KLD 400 Social and MSCI USA ESG Leader Equity, to name but a few.

Checking a company’s ESG rating is also a good starting point when screening potential investments. Independent financial research and analysis firms such as Morningstar and Bloomberg offer services that collect and verify ESG data.

Index providers such as MSCI and FTSE Russell as well as rating agencies have seen quite a bit of consolidation in the ESG space this year.  

Michael Jantzi, CEO of Sustainalytics, told the Financial Times that the wave of ESG deal-making reflects the need for ESG rating providers to be able to meet the need for expertise. “Global scale has become important,” he said.  

It also may be surprising to see that a lot of the top holdings in these funds and ETFs include well-known, large-cap names such as Microsoft [MSFT], Alphabet [GOOG] and Johnson & Johnson [JNJ].

In some cases, even utility companies meet the ESG criteria, which might not please all ESG investors. That is why it’s important for traders to decide what ESG characteristics are most important, so they can avoid dilemmas that might arise from the disparity between different ESG ratings.

Expectations should also be realistic, according to Susana Penarrubia, head of ESG integration at DWS, a firm that has two ESG ETFs. “It’s a starting point,” she said in the FT. “We get an indicator; this is not the whole story.”

 

Millennials to lead the way

There’s a growing appetite for ESG investing, with some 85% of individual investors and 95% of millennials saying they’re interested in taking a sustainable position, according to a recent report by Morgan Stanley.

95%

of millennials interested in taking a sustainable position

  

While that could ultimately end up influencing changes in corporate behaviour, long-term performance and returns are set to remain key factors in determining investment positions.

In spite of the enthusiasm from the 1,000 surveyed in the Morgan Stanley report, just over half are actually engaged in “at least one sustainable investing activity”, whether that be screening investments or divesting from non-compliant stocks.

For Luke Oliver, head of index investing at DWS, a “transfer of wealth to the millennial generation” could help shift the balance.

Oliver told CNBC that with somewhere in the region of $30trn set to be transferred from baby boomers to millennials in the next two decades, “companies are going to have to sit up and take notice”.

“In particular, there has been a surge in demand and interest from the millennial generation who understand that profit and purpose are linked and believe their investments are a way to express their values. Investment managers who are preparing for this demand through launching impact investing products are thought to be well positioned for millennial investments,” Investec’s Niklasson adds.

“Investment managers who are preparing for this demand through launching impact investing products are thought to be well positioned for millennial investments” - Therese Niklasson

 

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