Interest is growing among individuals to incorporate sustainable investing in their portfolios. Demographics have contributed to this trend (with higher interest levels among younger adults and women), as well as growing concern around climate change. In addition, tools for evaluating companies with respect to sustainability have improved over time and increased in number, making research easier.

What is sustainable investing?

Defining sustainability is a challenge, as individuals have different interpretations. For example, one may think companies producing GMO-related products advance sustainability, while another may want to exclude companies with activities in this type of business. The lack of clear definition poses a big challenge for advisory firms seeking to provide a sustainable investing solution for their clients in a mutual fund vehicle.

Jon Hale, Director, Sustainable Investing Research at Morningstar defines sustainable investing “as any approach that includes environmental, social, and corporate governance, or ESG, criteria and their impact anywhere in the investment process.”

What does the research say about returns for a sustainable investing approach?

Individuals often indicate they are willing to accept lower returns for following a sustainable investing or values-based investing approach. But do these investors actually sacrifice performance?

Dimensional Fund Advisors (DFA) tried to tackle this question in a May 2017 research article titled “Market Returns Compared to Strategies Excluding Energy and Utilities”. They compared the historical performance (January 1975 to December 2016) of the US equity market including all industry sectors with the US equity market excluding energy and utilities companies (a proxy for sustainable investing). Their results show that excluding energy and utilities companies did not have a significant impact on average returns. DFA then looked at international markets and found a similar result. They conclude the results support the belief that prices and valuations, not the company’s industry, are drivers of expected returns.

Morningstar’s Jon Hale also cites research from Oxford that supports this view. After analyzing almost 200 studies, reports and articles on sustainability, Oxford reports “80% of the studies show that stock price performance of companies is positively influenced by good sustainability practices.” It does seem logical that companies embracing good sustainable practices in their businesses should turn out to be good long-term investments.

This research indicates that following a sustainable investing strategy doesn’t have to mean giving up expected return.

HTG’s approach to sustainable investing

To date our approach has been to:

• Listen to what our clients’ top concerns are and
• Seek a diversified, research-based mutual fund that consistently applies a rules-based process for identifying sustainable companies.

Environmental impact and climate change are top on the list of sustainable investors’ concerns. Dimensional Fund Advisors (DFA), a core fund provider in our portfolios, offers both US and international sustainable solutions that we use for interested clients.

DFA has offered the US Sustainability Core 1 and International Sustainability Core 1 equity funds since March 2008. DFA applies a sustainability scoring framework over their usual emphasis on smaller, value-oriented and higher profitability companies. Sustainability scores are based on a blended variable whose primary component is greenhouse gas emission intensity, followed by four other environmental impacts. The process emphasizes environmental sustainability at both the portfolio and industry level, giving a higher weighting to industries/companies with higher sustainability scores and minimizing or excluding those with lower scores. More information can be found on DFA’s website.

While DFA’s process may not conform exactly to each individual’s definition of sustainable investing, we believe it offers a well-conceived, thoughtful way of including sustainable investing in the portfolio construction process for interested investors.

We expect the trend of greater interest in sustainable investing to continue and plan to follow research developments in the evolution of rules-based strategies available to investors. Please feel free to contact us if you would like to learn more.