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September 2017

Investing with a Conscience

Following your convictions doesn’t mean having to sacrifice performance.

Socially Responsible Investing Want your investment choices to be about more than just returns?

Socially responsible investing, which takes in environmental, social and corporate governance considerations, has moved rapidly into the mainstream. Like choosing electric vehicles or shopping local, more and more Canadians also want their investment portfolios to reflect their values.

The 2016 Canadian Responsible Investment Trends Report reveals responsible investments now hold over $1.5 trillion in assets, a staggering 49% jump in just two years. That represents nearly 40% of Canada’s investment industry. But, contrary to popular belief, investing responsibly doesn’t have to mean settling for subpar results.

The ABCs of SRI

Socially responsible investing (SRI) is nothing new. NEI Investments’ Ethical Funds, for example, can trace their roots to their Ethical Growth Fund launched in 1986. Whether you know it as socially responsible, green, ethical or sustainable investing, what’s changing about investing with a conscience is how it’s done.

Historically, SRI relied heavily on negative screening when selecting investments, avoiding companies whose activities failed to meet an investor’s ethical hurdle. That often meant leaving entire industries like tobacco, gambling or nuclear power out of portfolios. But increasingly, SRI has moved beyond being simply exclusionary and toward integrating environmental, social and governance (ESG) factors into corporate risk assessment, favouring businesses which demonstrate leadership in these key areas.

Examples of Environmental, Social and Governance (ESG) Factors
Examples of Environmental, Social and Governance (ESG) Factors
Climate change & carbon emissions Customer satisfaction Board composition
Air & water pollution Data protection & privacy Audit committee structure
Biodiversity Gender and diversity Bribery and corruption
Deforestation Employee engagement Executive compensation
Energy efficiency Community relations Lobbying
Waste management Human rights Political contributions
Water scarcity Labour standards Whistleblower schemes
Source: CFA Institute. Environmental, Social and Governance Issues in Investing. October 2015

A benefit of employing ESG analysis is it expands the universe of potential investments, enabling a responsible investor to build a well diversified portfolio. That’s important, particularly in resource-laden markets like Canada, where extractive sectors, namely energy and materials, make up a sizeable chunk of investment opportunities.

So, for example, rather than bypassing oil companies altogether, an ESG filter can identify those firms which are best-of-breed at limiting harmful emissions from operations, promoting water stewardship or investing in clean tech.

The growing clout of SRI has given responsible investors still another lever to pull: shareholder advocacy. Professional money managers who follow ethical ideals can act on behalf of their investors or mobilize fellow shareholders to push companies to make positive changes to their business practices. That means in situations where SRI principles start to exert influence at the board table, even companies with less-than-stellar ESG track records can be transformed into appealing investment opportunities.

Negative Screening Strategy Still Captures Most SRI Dollars Globally
Negative Screening Strategy Still Captures Most SRI Dollars Globally
SRI StrategyDollars Managed (USD)Predominant Market
Negative / exclusionary screening $15.02 trillion Europe
ESG integration $10.37 trillion U.S., Canada, Australia, New
Zealand, Asia ex-Japan
Corporate engagement / shareholder action $8.37 trillion Japan
Source: Global Sustainable Investment Alliance, 2016 Global Sustainable Investment Review

More than a feel-good story

There’s a common perception that SRI underperforms and is riskier than investing in financial markets broadly. However, numerous studies say firms who meet high ESG standards have not only performed better than their peers, but done so with less stock price volatility much of the time.

According to Morgan Stanley, the MSCI KLD 400 Social Index, representing companies which score highly on ESG criteria, outperformed the benchmark S&P 500 Index in the U.S. by 45 basis points on an annualized basis – 10.14% versus 9.69% – measured over a 25-year period. What’s more, sustainable equity mutual funds demonstrated equal or higher median returns and equal or lower volatility than traditional funds in two-thirds of time frames analyzed.1

It’s been a similar story here at home. The performance of the Jantzi Social Index (JSI) consisting of 50 Canadian companies that pass a broad set of ESG criteria while excluding companies with significant involvement in nuclear power, tobacco and weapons-related contracting, has outpaced the benchmark S&P/TSX Composite Index since the JSI’s inception in 2000.2

These figures back up the argument that investing responsibly doesn’t have to come at the expense of performance. If anything, it may even enhance returns and reduce risk over time. This could be especially true going forward as ESG analysis continues to gain traction in the investment community.

Why ESG matters

Environmental, social and governance issues might not show up on a company’s financial statements. But that doesn’t mean they can’t impact its bottom line significantly. As past controversies surrounding Enron, Volkswagen and BP highlight, investors who ignore ESG factors when constructing a portfolio can pay a steep price.

On the other hand, investors who pair ESG assessment with traditional financial measures create a more powerful lens to view prospective investments, enabling more comprehensive analysis. That in turn can lead to sounder investment decisions, potentially increasing returns.

The importance of taking ESG issues seriously is underscored by the way businesses are valued today. In a recent paper Merrill Lynch cites research from Ocean Tomo LLC stating that in 1975 more than 80% of the corporate value of companies in the S&P 500 was found in tangible assets like property and equipment. Now the ratio has flipped, with intangible variables such as reputation, brand recognition, human resource practices or environmental impact driving corporate valuations. 3

It’s a good bet that businesses which do an effective job of handling ESG issues are the same ones that manage their overall operations efficiently, making them attractive candidates for investment. Conversely, those companies that neglect their climate impacts, working conditions or supply chains are putting their customer relationships, profitability and perhaps even their viability at risk.

How to play it

If SRI interests you, fortunately you have no shortage of options for how to put your money to work.

You always have the choice of picking investments directly. But, for the average investor, making sense of the reams of ESG-related information flowing from a growing list of companies would be a challenge. For most people, tapping into the benefits of SRI-focussed investment funds is the way to go.

In its latest RI Fund Quarterly Performance Report, the Responsible Investment Association identifies more than 200 mutual funds, exchange-traded funds and segregated funds in Canada which use ESG screening to select investments. They include domestic and foreign equity funds, fixed income, commodities and balanced mandates. Of course, SRI investment funds also offer all the advantages regular funds provide, including diversification, professional management and convenience.

While SRI funds may share a common ethical philosophy, it doesn’t mean they’re all the same. Funds vary in their objectives and how they implement SRI. Some may screen out investments in certain industries, while others favour integrating ESG criteria. Still others have a particular focus like gender equality or environmental leadership, or combine different approaches.

Don’t forget that basic money management rules apply, regardless how you invest. Look for funds with proven management. Pay attention to expenses. If you’re inclined to choose a fund that concentrates on a specific sector, be prepared to deal with extra volatility from time to time. In the end, your goal should be to pick investments which fit not only your values, but your investment objectives, time horizon and risk tolerance too.

The Morningstar Sustainability Rating

Only a small percentage of investment funds in Canada fall under the SRI umbrella. But they’re not the only players with a stake in SRI. Conventional funds will also hold investments that score well, or poorly, on ESG-related measures.

The Morningstar Sustainability Rating is a self-help tool which ranks how well companies held by a fund are managing their ESG risks and opportunities when measured against similar funds. The rating system can help you evaluate how funds you already own stack up on ESG criteria, or use it to review potential investments. It can also provide insight to how well an SRI fund is living up to its ethical billing.

Take a step in the right direction

Want to do good and at the same time build a bright financial future for you and those you care about? Socially responsible investing may be the solution. We can assist you with creating an investment plan that helps you make money while making a difference.

1 Morgan Stanley Institute for Sustainable Investing. Sustainable Reality: Understanding the Performance of Sustainable Investment Strategies. March 2015.

2 Sustainalytics, Jantzi Social Index August 2017 Total Returns

3 Bank of America Merrill Lynch. Impact Investing: The Performance Realities. November 2016.

* Mutual funds are offered through Credential Asset Management Inc. Mutual funds and other securities are offered through Credential Securities, a division of Credential Qtrade Securities Inc. Credential Securities is a registered mark owned by Aviso Wealth Inc.

* Investment Partner Disclosure

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