Should you choose responsible investment?

From a financial industry standpoint, investing responsibly means choosing companies that meet high standards regarding their environmental, social and governance (ESG) impacts. Environmental responsibility usually has to do with issues such as a company’s carbon footprint and use of green energy, while social and governance responsibility has to do with issues such as how involved companies are in supporting their communities and whether they promote diversity (e.g., including women and minorities on corporate boards).

Until recently, Canada’s responsible investment (RI) market was fragmented. This made it difficult for the typical investor to enter the space.

Before, “it was challenging for [investors] to find opportunities that were accessible and met their [investment] needs,” says Trish Nixon, director of investments with Toronto-based CoPower Inc., which offers loans to development firms for projects that reduce carbon emissions. “[Now,] we’ve seen increased demand for [retail] products that are not only financially solvent, but that also align with people’s values,” when it comes to their portfolios meeting ESG standards.

The good news is Canada’s RI segment has rapidly expanded since 2011, says a report by the Responsible Investment Association (RIA). Total retail assets reached $61.9 billion in Canada by 2013, and have continued to grow. And retail RI funds, including venture capital and mutual funds, grew from $13.48 billion to $17.5 billion between 2011 to 2013 alone—mutual funds accounted for about 37% of that total at the time.

Millennials want RI funds

Of all age groups, millennials are most interested in RI products. In fact, they’re 65% more likely than boomers to consider environmental, social and governance factors when making investment decisions, says a report from the Responsible Investment Association. And, millennials are more than twice as likely as boomers to be interested in investments dedicated to solving social or environmental problems.

But so far, millennials are primarily interested in whether the funds and companies they choose support the environment, says Fred Pinto, CEO of OceanRock Investments at Qtrade Financial Group.

Plus, there are now more ways to invest responsibly. Rather than just excluding companies from portfolios based on negative factors–such as their carbon emissions being too high–you can now access and leverage deeper analysis of companies’ ESG efforts.

For exampe, a process called norms-based screening involves considering how well investments meet broad international RI standards, and choosing companies that are trending toward meeting the highest ESG standards for their industries (e.g., an oil company will always have higher emissions than a non-oil company, but that oil company may also follow responsible operational practices compared to its peers).

Where to look for opportunities

In Canada, the energy and materials sectors make up nearly 33% of the TSX composite. So, when investing in the RI space and trying to diversify, investors who prefer fossil fuel-free funds and those who focus on choosing companies with lower environmental impact tend to turn to global opportunities.

Most investors will split their exposure between domestic and global RI exposure, says Nixon, which provides more options. “People still want portfolio diversification. So they ask, ‘What percentage of my portfolio can be completely green?’ And they look at how to fit socially responsible investments into their portfolios across other sectors and markets.”

Currently, Canadian-domiciled RI funds tend to outperform their respective benchmarks 63% of the time, on average, finds a 2015 risk-return report commissioned by OceanRock Investments. And if you look at other standard measurements including Sharpe ratios, they outperform 55% of the time.

Overall, RI funds with global exposure tend to see more outperformance relative to their benchmarks than funds that invest in solely Canadian, U.S. or international markets, the report says.

Fred Pinto, CEO of OceanRock Investments at Qtrade Financial Group in Toronto, says whichever regions you choose to invest in, it’s important to focus on RI strategies that look at all elements of a company. His firm works with Sustainalytics to screen stocks in Canada, the U.S. and globally. “When focusing on the environment, for example, you’re looking at companies’ operations, supply chains and the products and services they provide as a whole.”

And, even if a company operates in the energy space, he adds, that doesn’t mean it has to be excluded from a fund or portfolio that’s focused on environmental impact. Pinto explains, “Suncor is in our portfolio because they gave done a fairly good job of containing the issues they have in the oil sands.” And it hasn’t disregarded ESG factors, he adds.

There are also emerging market and European opportunities, says Pinto. “[But] we have more developed markets screened in because the environmental standards of undeveloped countries aren’t at the same level as developed countries. We have a developed market bias.”

More choice

One positive development is more retail funds are launching, says Annette Quan, a financial advisor for Manulife Securities in Victoria, B.C. When she first entered the RI market, the biggest players in this space were Meritas, NEI and IA Clarington and AGF. “These were the [main] mutual fund companies where I knew I was getting a true RI fund that matched my values.”

Why? While other managers were also using ESG screening at the time, these four funds specialized in RI. “Their screening involves avoiding companies that do harm, [such as] companies that produce tobacco and weapons.” But they also “proactively invest in companies that show leadership in ESG criteria and shareholder engagement.”

Now, more companies are also offering ETFs and mutual funds that use similarly comprehensive processes, she notes. Some are also becoming signatories to, and thus are supporting, RI principles and values that are backed by the United Nations.

As a result, there’s more information out there about funds that meet RI criteria. That includes reliable performance numbers over the short, medium and long term. Says Quan, “These charts show RI products can perform at the same level or beat the returns of mainstream funds and benchmarks.”

One set of charts from the RIA looks at the performance of RI funds in Canada over the past five years, as of March 2016. In particular, the average returns of RI funds in the global equity class beat the average returns of non-RI funds over a three-month, one-year, three-year and five-year period, says RIA.

One reason for outperformance is that the managers behind these funds tend to do more research than the managers of non-RI funds, says Quan. “When I got into [RI] five years ago, I was frustrated with markets and wanted to protect my clients’ money. Due to the extra layer of screening for RI products, you’re reducing exposure to non-traditional risks that aren’t usually looked at.”