Domestic RI portfolios: Are they viable?

Until recently, Canada’s responsible investment (RI) market was fragmented. This made it difficult for retail investors to enter the space, says Trish Nixon, director of investments with Toronto-based CoPower Inc., which offers loans to development firms for projects that reduce carbon emissions.

“It was challenging for [investors] to find opportunities that were accessible and met their needs,” she says. “[Now,] we’ve seen increased demand for [retail] products that are not only financially solvent, but that also align with people’s values.”

In fact, 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.

Read: Morningstar rates 20,000 funds for sustainability

Plus, RI now encompasses more than simply excluding companies from portfolios based on negative factors, such as high carbon emissions. Instead, investors can leverage deep analysis of companies’ environmental, social and governance (ESG) efforts, or use norms-based screening, which measures how well investments meet broad international RI standards.

Millennials want RI

Of all age groups, millennials are most interested in RI products. In fact, millennial investors are 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.

Read: Millennials want advisors who know about responsible investing

“Offering RI solutions is an opportunity for advisors to attract these clients,” says Fred Pinto, CEO of OceanRock Investments at Qtrade Financial Group. So far, most young investors are primarily interested in whether the funds and companies support the environment, he notes.

Where to look for opportunities

In Canada, the energy and materials sectors make up nearly 33% of the TSX composite. To diversify in the RI space, investors who prefer fossil fuel-free funds and those that focus on environmental impacts tend to turn to global opportunities, says Fred Pinto, CEO of OceanRock Investments at Qtrade Financial Group in Toronto.

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.”

Read: New fund rating measures exposure to green companies

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, 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.

Whichever regions clients choose to invest in, it’s important they focus on RI strategies that look at all elements of a company, says Pinto. 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.”

Read: Why one fund company won’t dump fossil fuels

Even if a company operates in the energy space, for instance, 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.

Read: Ethical investing in trusts

Pinto’s firm also manages the Meritas International Equity Fund, which includes exposure to pharmaceutical companies, like Roche Holding Ltd. and Teva Pharmaceutical Industries. That fund also holds global companies in the consumer staples and IT spaces. The fund has seen negative returns so far this year, but its three-year and five-year total returns are 10.24% and 8.23%, respectively.

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.”

Read: Volatility increasing in emerging markets

More choices for investors

The good news for clients who want RI 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.”

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

As a result, there’s more information 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.” (See “Help clients understand RI,” below.)

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 those of typical 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 [clients’] exposure to non-traditional risks that aren’t usually looked at.”

Read:

Opportunities growing in green bonds

Responsible investing can offer better returns: study

Help clients understand RI opportunities

Annette Quan, a financial advisor for Manulife Securities, uses these four strategies, in order, to educate clients.

1. When a client first asks about RI options, she gives him a questionnaire to determine his values (e.g., is he focused on the environment or corporate governance?). She also explains that some funds look at environmental, social and governance issues, while others lean toward one area. 2. She may then ask a portfolio manager to join the meeting to explain how RI funds are managed and screened. 3. Next, she looks for possible investments based on her client’s risk level and time horizon. For more conservative clients, she focuses on A-plus-level funds and fixed-income solutions, versus equities funds. 4. Finally, to ensure her client is comfortable with switching to RI funds, she compares the funds with the investments he’s currently holding. “If we’ve got a balanced portfolio or income portfolio, for example, we’ll compare it with a fund in the RI space to assess returns.” Quan also compares the fees of both types of funds. But, she says, “The MERs, or fees, for RI mutual funds are no higher than those of mainstream mutual funds. As with all investing, you have to do your homework.”