27 August 2021
Australians increasingly are interested in how they can make their activities accord with their views about environmental sustainability. Where to start? A good first step is defining your goals and understanding the trade-offs.
These trade-offs apply as much to organisations like companies, customer-owned mutuals and non-profits as they do to individuals. And they require a holistic, stakeholder approach that encompasses our roles as community members, consumers and investors.
For instance, as a household or business, your may be considering installing solar power. You’re motivated primarily by reducing your use of fossil fuel-derived energy sources. But you also want the financials to add up in the long run.
A local council may be seeking feedback on a proposed multi-storey development near your home or offices. You understand the need for medium-density housing to reduce urban sprawl, but you’re also concerned about the resulting rise in noise and traffic.
As consumers and as citizens and enterprises, we’re constantly faced with such trade-offs in making decisions around sustainability. In investment, it’s no different. We want to do the right thing by the planet, but we also want to meet our long-term wealth goals.
Finding the balance
The good news is that it is now possible to build an effective investment solution that maximises your chances of getting to where you want to be financially, while reducing the carbon footprint of your portfolio and focusing on other environmental and social variables.
The key to this approach to investment is to ensure you stick to core investment principles, such as building your portfolio around the long-term drivers of return, diversifying broadly to manage risk, and keeping your costs low.
Once those elements are in place, you can reduce your exposure to companies with the highest greenhouse gas emissions intensity (a measure that adjusts for company revenue). At the same time, you can overweight companies with lower emissions intensity.
But you also need to account for the supply side of emissions – companies with large amounts of fossil fuel reserves which can be viewed as potential emissions to be generated once these reserves are harvested and consumed.
Alongside emissions, you can take account of other environmental issues like land use, biodiversity, toxic spills, operational waste and water management. And you can consider social issues like child labour, alcohol, tobacco, gambling and firearms.
In all of this, you shouldn’t sacrifice diversification. That means that after disqualifying the worst polluters, you should measure companies against their industry peers. The least sustainable can be excluded, while the rest can be overweighted or underweighted based on how well they rank within their industry. By using this scoring system, rather than a binary screening process, you can preserve diversification while encouraging good behaviour.
A holistic approach
It’s important to understand that no single investment solution will ever tick every box for everybody. But you can go a long way to meeting your goals if you supplement your choices as an investor with your choices as a consumer, community member or citizen.
For instance, while there may not be an option in your investment portfolio to invest in recycled plastic and paper, you could decide to insulate your home or business with such products. No wind or solar farms in your portfolio? Why not switch to an electricity provider that relies on renewable energy?
Measurement is another key. Just as a weight loss program makes no sense without a set of scales, you need to be able measure your exposure. In a global sustainability portfolio, emissions intensity can be cut by 80% or more and up to 100% for potential emissions.
A further consideration for investors and businesses in Australia is to be mindful of the impact of sustainability and social screens in a market that is already, by global standards, small and highly concentrated.
For instance, excluding large carbon-intensive companies from an Australian share portfolio over the past three decades would have led to a portfolio that looked significantly different to the market at times given the weight of miners locally.
This ‘tracking error’ can be ameliorated by taking a global approach to sustainability. In other words, the less your bias to domestic stocks, the less likely you are of straying a long way from the index as large local companies become a smaller part of your total portfolio. And given the higher emissions intensity of Australia, shifting the weight to global equities also leads to a lower carbon footprint for your portfolio.
The key point to take away is that investing well and sticking to your values around sustainability need not be incompatible concepts. But as always you have to take a systematic approach, one that observes the principles of diversification and one that targets the sources of higher expected return.
Jim Parker is the Sydney-based Regional Director, Communications with the Australian arm of global asset manager, Dimensional Fund Advisors.
Founded in the US 1981 and present in Australia since 1994, Dimensional has a long history of applying academic research to practical investing. The company now manages more than $800 billion from 13 offices globally, including about $45 billion for clients in Australia and New Zealand.