Climate change-aware investors need to blend sense and sustainability

It is a truth universally acknowledged that a would-be sustainable investor should look below the surface of any ‘green’ investments.

Through the jangling noise of politicians arguing over Brexit in the coming weeks, you might just about hear discussion about climate change. Regardless of how optimistic you are that your chosen party will fulfil any environmental promises, you may feel that putting a cross in a box is insufficient. Increasingly, people are looking to use their investments to make a difference. However, it is more complex than it may seem.

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Do investors have to choose between green and greed?

The simplest starting point for a would-be sustainable investor is to exclude the worst-offending companies and sectors. We completely avoid the traditional energy and coal mining sectors, which constitute as much as 12% of the global index and, therefore, appear by default in many passive funds.

Even those with no commitment to sustainable investing and doubts about climate change may want to reduce exposure to these sectors, given the change that protesters are driving in the political climate.

A sizeable chunk of the stock market is invested in carbon assets and facing headwinds that are growing stronger. With the world’s biggest pension funds and investors everywhere jettisoning these stocks, there is a danger for those who do not follow suit of waking up one day to find that they are the last ones playing hot potato, and are unable to sell.

It is tempting to rule out mining altogether, but unfortunately that may have unexpected repercussions. Many of the materials necessary for electric batteries are mined. Without them, the potential for storing clean energy is undermined. 

While studying the negative screen, you may also want to exclude airlines, which offer cheap weekend fares to foreign climes only because they benefit from tax-free aviation fuel. Depending on how strongly you feel, you might veto car manufacturers too. Or would you still include those producing electric cars or global leaders, such as Toyota, that have the scale to bring low-carbon vehicles to the mass market affordably – as they did with reliable, efficient petrol cars?

At the same time, you may want to consider wider exclusions – we exclude munitions, tobacco and gambling sectors. Lots of investors would prefer that, and we believe that you can generate decent returns without them. We also limit exposure to countries with fragile or unreliable government – primarily emerging markets, such as Russia, where there is a risk of assets being appropriated.

Be warned though: negatively screening too much out can harm returns. It is time to think positively. What will you include?

Renewable energy is one area that will appeal. The wind farm industry has reached a tipping point. It used to exist only through subsidies, which made it risky for an investor because politicians are prone to pulling the plug on subsidies without notice.

Recently, the tech has improved, the subsidies have gone and the industry has shown that it can survive unaided, although it may not be as profitable as many hope and investors should be careful about valuations in fashionable stocks.

Not all renewable energy is entirely good for the planet. Solar panel production involves a considerable amount of heat and toxic chemicals, and workers face risks associated with inhaling silicon dust.

Tidal energy can be detrimental to wildlife, and storms put the hardware under severe stress. We have already raised the issue of batteries. In Japan, researchers are exploring the potential of hydrogen fuel cells, which may improve the efficiency of battery technology, but these will still require rare natural resources and the manufacturing process is pretty filthy, doing little for the environment.

There are less obvious ways of investing for the planet. We own a couple of US railroads, Norfolk Southern and Union Pacific, which are helping to take freight off the highways.

Around 15% of our portfolio is in automation – investments in factory automation can increase productivity at a low environmental impact. This can lead to headcount reductions, but the savings can lead to growth, creating jobs elsewhere, and automation is a long way from eliminating the need for humans.

Amid all this, your portfolio must still be diversified, balanced and loaded with companies capable of delivering healthy returns. That is possible, and if you do your research well there are plenty of companies in sectors, such as information technology, healthcare, communications and property, that are sustainable.

If this sounds too complex, pick a fund. This is not easy either. Many “sustainable” funds can be accused of “greenwashing”. Some own shares in Shell, for example. Their managers argue that Shell is more green than other oil stocks and that this appraisal justifies the investment. But we do not agree and think that investors who thought they were buying a green fund would be shocked.

Ultimately, you have to look at not just what the marketing literature says but what is in the fund – most factsheets show the top 10 holdings, which can help (we show the top 30).

At the other end of the spectrum are investment managers who devote much of their energy towards satisfying the increasingly convoluted thresholds and criteria set by the growing array of ESG ratings agencies. Many are of dubious benefit and can needlessly harm returns.

We avoid box-ticking exercises and focus on the key priorities, so although we achieve strong carbon rating scores, we do not shoot the lights out on broader ESG scores.

Most investors want sustainable returns and do not want to damage the planet or society in the process. In the end, there has to be a pragmatic balance, you might call it “sense and sustainability”.

In short, listen to what a fund manager says and examine their green ratings, but also examine how they have performed and investigate what they hold, and only then decide if their fund meets your needs.

Simon Edelsten is co-manager of the Artemis Global Select Fund and the Mid Wynd International Investment Trust.

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