There are broadly three ways in which people can push for a greener future without gluing themselves to the floor outside Downing Street - through who they vote for, what they consume and where they invest.
There is now a good range of sustainable funds available to UK investors and while still relatively small, the amount of money invested in these trusts is growing. In the second quarter of 2020, retail investors ploughed £2.5 billion into responsible investment funds, compared with £0.8 billion in the same period last year. Sustainable funds still only make up 2.7% of invested assets however, which gives plenty of room for further growth.
Funds take different approaches to responsible investment, which means investors do have to do a bit of extra homework to check the fund they choose matches up with their ethical goals. Environmental goals are often married with societal concerns and governance standards to create funds which sit under the ‘responsible’, ‘ethical’ or ‘sustainable’ umbrella.
Managing risks of sustainable investment
Investing ethically can also mean that you have a very different portfolio to world stock market indices and other investors. That’s not necessarily a bad thing, but it can mean extended periods of both outperformance and underperformance. It can also lead to additional risk in the portfolio, for instance through exposure to smaller companies and emerging technologies.
Investors shouldn’t let the perfect be the enemy of the good in this regard and could consider mixing traditional and ethical funds to create a more diversified and less risky portfolio. Clearly this isn’t as clean as a pure ethical portfolio, but it’s a pragmatic solution to creating a balanced portfolio that also has a positive societal influence.
As ESG issues rise up the priority list for company boards, we can expect an increasing number of companies to fall into the investable universe for ethical funds, which will allow even greater diversification in portfolios. For instance, BP has promised to reduce carbon emissions to net zero by 2050. Phillip Morris, the manufacturer of Marlboro and Chesterfield cigarettes is shifting to new products to ‘deliver a smoke-free future'. Very long term goals for sure, some may say flapping in the prevailing wind, but a significant change in direction of travel nonetheless.
Ethical funds typically fall into one of three buckets
Ethical funds typically fall into one of three buckets; funds that aim to do no harm, funds that aim to do some good and specialist funds.
Funds that aim to do no harm screen out any ESG transgressors. Typical examples of exclusions include gambling companies, arms manufacturers, fossil fuel producers and tobacco companies.
Funds that aim to do some good actively seek out companies which are making positive contributions to society and the environment.
Specialist funds target specific areas of ESG like clean energy (e.g. iShares Global Clean Energy ETF) or gender diversity (e.g. Legal & General Future World Girl Fund).
What about tracker funds?
Traditional tracker funds don’t have any ESG screens and simply allocate money to stocks in the index passively. If Shell is 5% of the index, a FTSE 100 tracker is simply going to place £5 out of every £100 into Shell stock. However, tracker companies can take an activist approach to engaging with companies (see Legal & General below), but they lack the final sanction of upping sticks with their money.
There are some funds which track ethical indices, produced by the likes of FTSE and MSCI. Much like with an active fund, investors should check the sustainable criteria to make sure investment is aligned with their own goals – this time it’s the index they need to look at rather than the fund.
Traditional funds are becoming more ESG aware
Increasingly traditional funds are building ESG considerations into their standard process, as a way of flagging risks stemming from these issues. The BP Gulf of Mexico oil spill, the Volkswagen emissions scandal and Boohoo Group’s failure to properly manage its supply chains are all examples of ESG failings which caused environmental and societal harm, but which also prompted steep falls in the companies’ share prices. That’s something no fund manager wants in their portfolio.
There’s also an increasing willingness to engage with companies on ESG issues by some fund management companies, using their shareholder voting rights to turn the screw on issues they feel are important. Only this week Legal & General said it will use its voting power at shareholder meetings to try to increase ethnic representation on UK boards.
The problem with investing sustainably in some sectors
There are legitimate reasons why ethical funds don’t necessarily work in some investment sectors right now, in particular those funds with more restricted remits. Consider income funds for instance, which already won’t invest in some stocks because they don’t pay a dividend. Further restricting the pool of investable stocks using an ESG filter could narrow the manager’s choice down to a point where they would find it difficult to deliver their primary target of a decent income for investors. Fund innovation in these areas therefore requires greater sustainable investment options on world stock markets, which will take time.
Sustainable fund options
Peter Michaelis, head of the sustainable funds team at Liontrust, has been investing in sustainability since 2001. That’s two years before Greta Thunberg, who has done so much to raise the profile of climate issues, was born! This fund invests across the global stock market in companies that are driving sustainable growth. The fund doesn’t use negative screening, it selects companies based on their positive societal benefit.
Manager Mike Fox has been involved in this fund since 2003. It invests exclusively in the UK stock market and uses positive screening for ESG factors.
The fund invests across the globe in high quality companies are positioned to benefit from the sustainable development of the countries in which they operate. Manager Nick Edgerton has been managing the fund since 2012 (as co-manager until 2016).
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