Investing in five funds for climate change

Like many, I believe we can all do more to address climate change – and that Australia should do its part (and then some) to respond to the problem. But some climate-change commentary during summer was alarmist, shamefully politicised and commercially opportunistic.

The world’s top bank, the Bank of International Settlements (BIS), this month told its central-bank members to incorporate climate change into their thinking on financial stability. BIS said banks should think about “green-swan” events and having to save the financial system.

Meanwhile, the International Monetary Fund warned that global warming has become a major financial risk; a PwC survey identified rising fear among CEOs that climate change threatens growth; and BlackRock CEO Larry Fink focused on climate change in his widely read annual letter and foreshadowed a reallocation of capital to sustainable strategies.

Predictably, fund managers were quoted in the media on ways to make money from climate change, mostly by buying global stocks or a small group of local renewables companies. They forgot to mention that many of these stocks are too speculative for conservative investors – and that lots of local renewables stocks have performed poorly for shareholders over the years.

To be clear, I’m not disputing the reports or the need for industry to respond to climate-change risks. Better corporate transparency and reporting on non-financial risks – so that investors can make informed decisions on sustainability leaders and laggards – is needed.

But I can’t recall so many business-related, climate-change reports or surveys at once. Financial markets, it seems, are poised to reallocate capital faster from industries and companies that have poor sustainability, to those with higher ratings in this area.

Retail investors will need to pay extra attention to Environmental, Social and Governance (ESG) ratings of companies. Those with consistently higher ESG ratings could achieve a higher valuation premium, and underperformers could be marked down more aggressively.

ESG a defining issue

To recap, ESG has become a key issue in institutional investing in the past decade. Almost half of all assets professionally managed in Australia are now put through responsible filters, according to the latest survey from the Responsible Investment Association Australasia.

Simply, fund managers are under pressure from super, pension and sovereign funds to assess non-financial risks of companies, such as climate change, and factor them into their investment decisions. Chances are your superannuation fund has an ESG overlay built into its investment process.

An entire industry of ESG data providers and analysts has developed and the process is spreading across asset classes, beyond equities and fixed interest. More growth is likely: investment bank Credit Suisse in January tipped sustainable investing – a megatrend years in the making – to be the dominant investment theme this decade.

Assessing a company’s non-financial risks makes sense as climate change, modern slavery, organisation culture and other issues have a greater impact on company value. However, ESG requires specialist data and is complicated for retail investors.

Investors who want to ensure their portfolio is on the right side of long-term sustainability trends – a sensible move to protect and build wealth in this environment – need to use active or passive fund managers that have proven ESG overlays in their investment process.

For some investors, that means using ethical actively managed funds that negatively screen out harmful sectors such as weapons and tobacco, or companies involved in fossil fuels, traditional plastics, deforestation or other activities deemed to harm the planet.

My preference is funds that employ negative and positive ESG screening across sectors. It’s too simplistic, for example, to avoid the mining sector when BHP, Rio Tinto and Fortescue Metals Group are doing good things in sustainability and rewarding investors.

I like the look of some new Exchange Traded Funds (ETFs) that have in-built sustainability overlays. They are a low-cost, convenient way to build a portfolio of companies that have higher ESG ratings and avoid those with low ratings. Several have performed well since launch.

Some actively managed funds in sustainable investing also have a good record and a smart way to improve risk-adjusted returns, through better assessment of ESG risks such as climate change.

Here are 5 funds worth considering:
 

1. BNP Paribas Environmental Equity Trust

The equities trust suits investors who want to ensure their portfolio has a positive environmental impact. It invests in global companies with at least 20% of their revenue, profits or capital employed in environmental markets.

BNP believes resource efficiency – using the earth’s limited resources in a sustainable way and minimising waste – is an under-researched part of the market. The trust’s top holdings include global energy efficiency, pollution control and energy infrastructure and technology stocks.

The trust is a good choice for investors who want more renewables-style exposure, but won’t suit those seeking broader industry exposure. BNP was the inaugural winner in the Sustainable and Responsible Investments category at the 2019 Zenith Fund Awards.

The trust returned 23.2% over one year to end-November 2019, a touch ahead of its benchmark MSCI All Country World index. It has returned 10.35% since inception in 2017, a few percentage points below benchmark.

2. Australian Ethical Australian Shares Fund

The actively managed fund invests in a diversified portfolio of mostly ASX-listed companies, based on their ESG and financial credentials, in accordance with the firm’s ethical charter. Australian Ethical is an ethical investing pioneer and a local leader in this field.

Four of the fund’s top 10 holdings are banks and other key exposures are in healthcare and telecoms. The fund is a good option for investors who want exposure to companies across sectors that have strong ESG credentials, rather than only focusing on narrow sectors.

The fund returned almost 24%  over the year to end-November 2019 and has consistently outperformed its benchmark index since inception in 1994.

A possible drawback for conservative investors is that almost 60% of the fund is invested in Australian and New Zealand small-cap stocks – a strategy that can lift returns and risk.

3. VanEck Vectors MSCI International Sustainable Equity ETF (ESGI)

ESGI, an index fund, is a new tool for investors who want to ensure the global equities component of their portfolio includes sustainable companies. The ETF incorporates positive and negative screening to enhance returns and reduce risks.

Launched in March 2018, ESGI excludes fossil-fuel companies, high-carbon emitters and others it deems to engage in socially irresponsible activities. It includes sustainability leaders. Its top holdings include Microsoft Corp, Home Depot, Salesforce.com and Allianz.

ESGI has started well, returning 27.3% over one year to end-December 2019.

4. BetaShares Sustainability Leaders Diversified Bond ETF (GBND)

Launched in November 2019, GBND is an innovative tool for retail investors to ensure sustainability with the bond component of their portfolio.

The ETF has strict eligibility criteria for bond issuers and green bonds in its underlying index must be certified by the Climate Bonds Initiative.

Some green bonds have been criticised for “greenwashing” – that is, appearing to be more sustainable than they are, or coming from companies that have other operations in sectors, such as gaming, that are perceived to be harmful.

BetaShares also offers the Australian Sustainability Leaders ETF and Global Sustainability Leaders ETF. Both track indices that screen companies on sustainability performance.

5. Russell Investments Australian Responsible Investment ETF (RARI)

RARI is weighted towards companies with strong ESG performance and screens out those in harmful sectors.

RARI returned 22.2 per cent over one year to end-December 2019. The ETF fund’s 12-month trailing dividend yield of 9.72 per cent (after franking credits) stands out.

Companies included in RARI had zero carbon reserves relative to ASX 200 companies and about half the carbon footprint of companies in that index, making the ETF a consideration for investors who want to limit carbon exposure in their portfolio.