Sustainne reached out to James Osborn of Envest Asset Management to answer some questions about investing in the age of climate change. We wanted to know whether sustainable investing had gone mainstream, whether it was possible to make a positive impact without sacrificing performance, and whether there was a means for individual investors to put their money where their values are using publicly traded securities (stocks, bonds, funds) in addition to private investments.
Sustainable Investing Q&A with James Osborn of Envest Asset Management
Q: Many of us care deeply about making investment choices that positively impact the environment and society, but we don’t want to sacrifice returns. Is it possible to make a profit while investing with purpose?
James: This is the most common question I receive. The short answer is yes. However, all investing comes with risks and need to meet an individual’s needs and tolerance for risk, etc.
For uniformity, let’s call this type of investing “sustainable investing.” Sustainable investing requires further explanation as there are some misconceptions. I would like to start by clarifying the definition. Any company that positively impacts the environment and society and has good governance (collectively and commonly referred to as environmental, social, governance or (ESG)) is a sustainable company. For example, companies that have good governance:
- are forward thinking;
- adapt to market dynamics, which include financial, environmental, and legal;
- reduce waste and costs through better supply chain management and materials management;
- reduce costs through energy efficiency and renewable energy procurement
For those reasons and many others, consider the following statistics for companies that have high sustainability ratings.
- Companies that have a higher deployment of ESG strategies (Environmental, Social and Governance) show higher return potential and are valued at a premium when compared to their peers.
- Companies that have higher ESG ratings tended to show higher profitability and dividend yield.
- A majority of corporate executives believe that a sustainable strategy is required to remain competitive.
- Investors play a large part in corporate sustainability and stewardship. Investors have shown a willingness to take action if sustainability issues are not being effectively addressed by the company.
Q. New York City’s five pension funds announced they would divest $5b in fossil fuel investments in January. Is it really possible for investors to get exposure to well-capitalized, fast-growing renewable energy companies while screening out oil and gas companies?
James: Certainly! According to the Guardian, a study conducted by Arabella Advisors shows a commitment from institutional investors with over $6 trillion in assets under management to divest from fossil fuels. The reason for divestment? Individuals, People! With institutional investors divesting from fossil fuels, their product offering to retail investors may follow suit. A client and their advisor may wish to discuss an energy-specific allocation that involves the switch from fossil fuel investments to renewable energy investments or look for other methods outside an energy sector allocation to decarbonize a client’s portfolio.
Attacking this problem from a different angle, there are multiple ways a person may wish to “divest” from fossil fuels. Specifically, Connecticut residents may want to consider more energy efficient practices, switch to renewable energy by purchasing renewable energy from a provider or consider roof-top solar power (or other renewable power) in lieu of power from the utility. The Connecticut Green Bank has offerings that may benefit property owners not only to divest from fossil fuels but also result in reduced energy and power expenses.
Q: From a risk management standpoint, it seems logical to avoid investing in companies that lack explicit environmental, social, and governance (ESG) mandates. Would you explain the type and scale of the risks these companies face in low and no-carbon economies?
James: Let’s start at the global scale. The effects of pollution can be felt around the world and with disastrous consequences. The US EPA recognizes that pollution can result in the following:
- respiratory symptoms
- heart or lung diseases
- premature death
- cause cancer, or
- other serious health effects, such as birth defects.
The World Bank estimates that air pollution costs the global economy over $5 trillion annually.
Interestingly, while there are many forward-looking estimations as to the economic impact of global warming, below are two graphs that represent the historical impact in the U.S. The first graph shows the number of billion-dollar events (over 270 since 1980) and associated total damage (over $1.6 trillion since 1980) due to climate-related events as compiled by NOAA through October 9, 2018.
The second graph represents the Actuaries Climate Index (“ACI”), “an objective measure of changes in extreme weather and changes in sea level relative to the base period of 1961 through 1990.” Used as a tool by insurance companies to assess potential financial consequences due to climate-related events, the ACI shows an upward trend of more extreme weather emerging in recent years.
Being a steward of the environment and society should compel anyone to invest in companies that have ESG mandates, particularly when looking at the above trends. Of note, Exxon Mobil is currently in a lawsuit with New York’s attorney general for shareholder deception related to climate change. The attorney general contests that Exxon Mobil defrauded investors for not accurately disclosing, “the risks posed to its business by climate change regulation.” The prosecution alleges that Exxon, “kept two sets of books when accounting for the effects of climate change.”
Q: How big is the marketplace for sustainable, responsible and impact investing (SRI)? How much money under professional management in the US is invested according to SRI strategies?
James: Sustainable investing can be thought of as a continuum. Using a sustainability scale of 0 to 100, companies with low sustainability will rank closer to 0 and those with higher sustainability will rank closer to 100. The value of all publicly traded securities is approximately $30 trillion in the U.S. stock market and approximately $40 trillion in the U.S. bond market, making the size of sustainable investing the entire market such that each traded security has a sustainability ranking, albeit ranging from very small or very large.
Narrowing it down to professionally managed accounts, there are now $12 trillion invested sustainably according to a just-released trends report from The Forum for Sustainable and Responsible Investment (US SIF). That’s up 38% from $8.7 trillion in just two years. Based on a total of $46.6 trillion in assets that are professionally managed, just over 25% or $1 of every $4 is invested sustainably.
Q: What strategies do you use to construct and manage sustainable portfolios for your clients? How do you screen for investments –individual equities, mutual funds, index funds and alternative investments – that meet a client’s particular sustainability requirements?
James: Constructing a client’s portfolio is a highly individualized process. Consideration must be given to the client’s budget, risk tolerances, return objectives, life changes, liquidity needs, investment horizon and many other factors. This means that an advisor/planner should talk to the client, listen to the client’s needs, goals and wishes, and educate the client about investment products that may be appropriate for the client’s investment and sustainability goals.
In general, there are two popular methods to construct sustainable portfolios through publicly traded securities: 1. Sustainability Indexing and 2. Ethics-based investing. Both can be used to identify investment opportunities in specific companies (via stocks or bonds), mutual funds or exchange traded funds (ETFs). When considering ETFs as the preferred investing method, examples of Sustainability Indexing can be found here, and Ethics-based can be found here.
Other sustainable investment opportunities could involve the use of alternative investments. These can be characterized by investments in private companies, i.e. companies that are not traded on an exchange. Clients must be accredited high-net-worth investors to invest in alternative investments.
Q: You are an independent, fee-only financial advisor serving as fiduciary to individuals and employee benefit plans. How do investors benefit from working with fee-only fiduciaries vs. non-fiduciary fee-based investment advisors that are bank or brokerage company employees compensated by commissions on transactions?
James: There are two key terms to know when working with a financial advisor: 1. Fiduciary and 2. Fee-only. They go hand-in-hand and result in reducing conflicts of interest between the client and the advisor.
If an advisor is fee-only, then that advisor is not motivated to recommend a financial product to a client based upon a commission. Fee-only financial advisors are paid solely from their clients and will never try to sell you financial products.
A fiduciary is ethically and legally obliged to put their client’s interests first. Legally, fiduciaries must meet “fiduciary standards,” where the advisor:
- Must place the client’s interest above the advisor.
- Must reveal any real or possible conflicts of interest to the client.
- Provide financial advice based on the most accurate and complete information.
In contrast, non-fiduciary fee-based advisors can be compensated by the client and earn commissions. In addition to being compensated by their clients for services performed, these professionals receive fees from third-parties by selling financial products. Non-fiduciary fee-based advisors are only held to the “suitability” standards, not fiduciary, which gives them latitude in their investment recommendations to their clients. This makes for a potential conflict of interest between the advisor and client such that an advisor may look to maximize current fee potential.
Q: When does it make sense to work with a financial advisor? Many people like to invest their own money and others feel they don’t have portfolios large enough to warrant hiring a professional.
James: There are financial advisors that work with all types of clients and all portfolio sizes. Money management is a learned skill. Considering that 65% of Americans save little or nothing, it is my belief that most people could use the help of a financial advisor. It’s important to have a financial plan and working with an advisor can help execute and modify that plan to meet your current and long-term financial goals.
Under Envest Asset Management (EAM)’s structure, we look at the environment (“E”) and social (“S”) underpinnings of Environmental, Social and Governance (ESG) Criteria to maximize sustainability. EAM’s mission is not only to increase awareness of global warming but also to increase financial literacy. If EAM can provide both, then it is maximizing its value proposition.
The Social pillar of ESG can have a significant social impact. Part of EAM’s mission is to increase financial literacy, which is why we DO NOT have minimum asset requirements. As reported in the Atlantic, increasing financial literacy can lead to being, “more likely to plan for retirement, make better investment decisions, refinance mortgages at the optimal time, and manage credit-card debt better.”
For the Environmental pillar of ESG, EAM’s mission is two-fold, 1. according to Nordea Bank investing in sustainable companies can be 27x more efficient in lowering a person’s carbon footprint; and 2. Discuss global warming. This discussion is critically important. According to the Yale Climate Opinion Map 2018, 61% of people are worried about global warming, 70% believe it will harm plants and animals, and 70% also believe it will harm future generations. However, only 36% discuss global warming occasionally.
The Bottom Line
There are many reasons to focus on efforts to reduce global warming. We are on course for disastrous events. But there is hope. There are many ways to actually reduce global warming by making small changes in our daily lives. One of the easiest and most impactful ways is our investment considerations.
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Visit EAM’s profile on Sustainne to learn more or to contact James Osborn.