Helping to make the world a better place through investing
For a growing number of investors, their portfolio is about more than just making money it is also about making a difference. Thanks to Socially Responsible Investing (SRI), it has never been easier to insure that your investment portfolio matches your views on a wide range of issues including the environment, alcohol, tobacco, firearms, and human rights.
Socially Responsible Investing the inclusion of social, environmental and governance criteria into the traditional investment management process. It is not a new idea and has roots dating back more than a century when the churches in Victorian England were not allowed to invest in armament manufacturers. Since then, churches, foundations, and other charitable organizations have worked to avoid investing in companies that are involved in many of the traditional “sin” type industries including tobacco, guns, and gambling.
Canada has been no exception with SRI being practiced by many churches since 1975. It wasn’t until 1983 with the launch of the first Labour Sponsored Investment Fund that SRI grabbed a foothold in the retail market. In 1986, VanCity Credit Union launched the country’s first SRI Mutual Fund – the Ethical Growth Fund.
SRI has become very popular among institutional and high net worth investors, yet has been largely ignored by individual investors. According to the Canadian Socially Responsible Investment Review that was published in 2010, it was estimated that approximately 20% of all assets under management in Canada were in SRI funds.
With individual investors, the uptake has been less than impressive, representing a very small portion of all assets under management. The Social Investment Organization estimates that as of March 31, there was more than $15.4 billion invested in SRI mutual funds and SRI labour sponsored funds, representing less than 2% of all mutual funds in Canada.
Over the years the concept has evolved from the exclusionary screening process that prevents investing in companies that are involved in alcohol, tobacco, nuclear energy and weapons. As practiced today, it places an increasing focus on environmental, social and governance (ESG) issues when evaluating companies. The process is also becoming more proactive, using such practices as shareholder activism and proxy voting strategies to enact change within companies by putting pressure on management.
There are two general types of Socially Responsible Investing strategies that are employed; Core SRI and Broad SRI. Core SRI is what we think of when we think of the traditional ethical investing that has been practiced for years. It typically involves the application of values based screens on any investment that is being considered for inclusion in the portfolio. Once the portfolio manager has identified a suitable investment candidate, the company will be put through series of screens that look to exclude companies that are involved in what the fund sponsor considers to be unethical activities. Alternatively it can look to include companies that are actively engaged in what are considered to be positive behaviours. Core SRI can also focus on community values activities which will include investing in community development initiatives that positively contribute to the growth and well being of particular communities.
Broad SRI strategies are considerably more complex because they incorporate environmental, social and governance (ESG) criteria into the investment selection process. Along with the traditional investment selection process, a portfolio manager will also assess the risks which may result from the company’s ESG record.
Portfolio managers will attempt to enact change within a company on a wide range of ESG criteria by engaging management on a wide range of issues, filing shareholder resolutions, and proxy voting. By using this approach, portfolio managers are looking to reduce potential losses which may arise from lawsuits, government action, or bad publicity resulting from a company’s ESG activities.
For investors, there are two main ways to access socially responsible investing; SRI mutual funds, or socially responsible labor funds. In Canada, labor funds make up nearly 60% of retail focused SRI assets. In fact, Fonds de solidarite FTQ has more than $8 billion in assets, slightly more than half of all SRI fund assets. Generally, we do not recommend Labour sponsored funds to investors. Given the long-term regulated holding periods, it is our opinion that the risks do not adequately reward investors for the potential return and tax credits which they may earn.
There are more than 60 mutual funds and one ETF operating in the SRI space in Canada. NEI Ethical, Meritas and RBC/PH&N are the main players in the space, offering a relatively wide range of core asset classes.
As highlighted above, investors have largely ignored SRI mutual funds. A big reason for this is that advisors have not embraced SRI funds for their client’s portfolios. Many advisors are unfamiliar with SRI, and many who are see it as nothing more than a niche product. Helping to fuel this perception is the fact that until recently, the majority of the funds were offered through smaller fund companies, while the majority of advisors tend to deal with the larger mutual fund complexes.
Another reason that SRI funds have had some difficulty in gaining traction is that the performance, except for a handful of funds, has been mediocre at best. Of the SRI funds that we follow, there are 25 which have a track record of five years or longer. Of those, only seven have finished in the upper half of their categories. One factor which has likely contributed to this mediocre performance is cost. In looking at many of the SRI offerings, the MERs tend to be in the upper half of the category average.
Another common criticism of socially responsible funds is that the screening criteria are subjective and may vary widely from one fund to another. What is considered taboo by one fund may be perfectly acceptable to another. There are no clear cut definitions of what SRI or ESG criteria are which can create confusion among investors.
Despite the challenges, there are a number of high quality SRI offerings available to investors. Some of our favorites include:
PH&N Community Values Bond Fund (PHN 610) – This bond fund, managed by the highly respected PH&N Bond Team looks to invest in bonds that are issued by Canadian governments and corporations that conduct themselves in a socially responsible manner. Even with the SRI overlay, this fund holds up well when compared to traditional bond funds. The portfolio looks very similar to the PH&N Bond Fund, which has been one of our favorite bond funds for a number of years. It is invested fully in Canada, and is well positioned for a rising rate environment. It has a shorter duration than the benchmark, which means that an increase in interest rates will have less of an impact on this fund. It also holds more than half of the fund in corporate bonds, which are expected to hold their value better when interest rates rise. The MER is 0.61%, which is in the low end of the category. Performance has been strong finishing in the first quartile in every year with the exception of 2008, when it finished in the second quartile.
RBC Jantzi Canadian Equity Fund (RBF 302) – In managing the fund, RBC Global Asset Management has partnered with Jantzi-Sustainalytics, one of the pioneers of SRI in Canada. The first step of the portfolio construction process is to narrow the investment universe based on a number of “Best of Sector” ESG screens that are determined by Jantzi-Sutainalytics. Each company is ranked on a number of qualitative criteria including corporate governance, environmental record, human rights practices, and how well it treats employees and customers. They will also exclude any company which derives more than 5% of its revenues from military weapons, tobacco, or nuclear power. Once this has occurred, the RBC GAM applies its multi-disciplined investment selection process, which combines a top-down macro view and a bottom up security selection approach to build the portfolio. In reviewing the portfolio, one thing which stands out as a bit surprising is the number of mining and energy names that it holds. However, these are the company is which are employing best practices and are considered to be the most responsible towards the environment. Performance has been respectable, generating a gain of 5.6%, outpacing the majority of its peers. Volatility has been lower than both its benchmark and the category average.
iShares Jantzi Social Index Fund (TSX: XEN) – This is currently the only SRI ETF that is available in Canada. It is designed to track the Jantzi Social Index which looks to invest in the large Canadian companies that have passed through screens for environmental, social, and governance factors. The index excludes any companies that are involved in nuclear power, military weapons, and tobacco. Despite the relatively low level of assets, currently at a paltry $17 million, there are a couple of reasons to like this ETF. First, the cost is very reasonable with an MER of 0.55%. Second, performance has been relatively decent. As of May 31, the ETF has a five year return of -2.4%, outpacing the majority of its peer group.
Ethical Special Equity Fund (NWT 067) – Managed by Joe Jugovic and Ian Cooke of Calgary based QV Investors, this small cap fund is extremely similar to the IA Clarington Canadian Small Cap Fund (please see our interview with Ian Cooke elsewhere in this edition). They look for financially strong companies that are managed by high quality management teams with a demonstrated history of generating high returns on equity and a vested interest in the company’s success to align interests with shareholders. The concentrated portfolio is managed using a value focused philosophy, looking to buy stocks well below their estimate of its true value. Other criteria that are considered are dividends. More than 85% of the companies held pay a dividend, an impressive feat in the small cap space. The biggest difference between the two funds is that the management team submits investment ideas to Ethical Funds who put the prospective company through their rigorous environmental, social and governance screens. Assuming it passes, it is allowed into the fund. Despite the ESG criteria, performance hasn’t missed a beat. In fact, the Ethical Special Equity has outperformed the IA Clarington Canadian Small Cap Fund, largely because it has a lower MER. Because of the value focused approach used, we expect that performance will lag in a sharply rising market, but is expected to hold up nicely in periods of high volatility and in down markets.
Ethical Global Dividend Fund (NWT 084) – This go anywhere fund managed by KC Parker of Beutel Goodman looks for high quality, profitable companies that generate high levels of free cash flow that is either reinvested back into the business, or returned to shareholders through share buybacks or dividends. Performance has been strong when compared to not only its peer group, but also the benchmark. As of May 31, the three year return was 7.8%, outpacing the MSCI World Index by nearly 30 basis points and finishing in the top quartile. Ethical are very active shareholders and encourage companies to improve their environmental, social and governance practices through dialogue, shareholder resolutions and proxy voting. They are not afraid to take action if a company does not want to play ball. For example, they recently turfed Great-West Life from the portfolio because they didn’t want to address or discuss the risk of climate change to its insurance business. Our biggest concern with this fund is its volatility, which has been above the benchmark and the category average. However, for investors who can stomach a bit more volatility in return for knowing they are investing in companies with a well defined ethical stance, this is a great fund to consider.
Bottom Line
For many people, helping to make the world a better place through their buying and investing activities is an important goal. Socially responsible investing is a way to help do that with their investments. However, SRI is not for everyone. Before investing in an SRI fund, an investor should ensure that the SRI criterion that is employed aligns with their beliefs. Investors should also realize that the costs they pay may be higher for an SRI fund compared to a non SRI fund, and as a result, performance may suffer.