"How to build a greener portfolio"
Consumer demand has made it easier to be green these days, by driving an array of environmentally friendly products, from energy-saving light bulbs to fuel-efficient cars. This mounting interest in environmental sustainability increasingly will influence consumers purchases -- and so, it also seems, their investments.
Across North America, individuals are pouring millions of dollars into specialty funds. This boon is just the tip of the iceberg, as profitable and/or promising companies gain profile in this space. But, will a green portfolio ensure average investors remain in the black?
The answer is yes. Investors can make money and help the environment at the same time. A number of global funds already generate impressive, double-digit returns.
Many of the gains stem from well-established, profitable companies that have developed innovative environmental technologies. (The Toyota hybrid-engine comes to mind.) But investors should be cautious of any investment theme touted as the "next big thing." As The Economist noted not too long ago, some green business has more to do with "relabelling than revolution flogging slightly more efficient versions of standard technologies as exciting innovations." Still with venture capitalists pumping billions in to startups, comparisons are being drawn between the green revolution and the dot-com boom. Hardly a comforting analogy.
For many Canadians, mutual funds are the best way to participate. So-called socially responsible funds have been available for more than 20 years. These funds are not exclusively focused on environmental stocks. However, many reflect investor values by using "negative screens" to eliminate non-desirable companies including heavy polluters. The funds can deliver respectable results, although, recently, the returns of many of them have been several points below the &SP/TSX Composite index for the three and five years.
A better approach for investors and the environment is to evaluate companies on qualitative and quantitative factors. This sustainable investing model relies on some investment principles:
The economics must be attractive. Several factors determine a company's ability to generate profit and in turn deliver value for investors. Some are objective, such as a company's capital structure. Others are subjective, such as the quality of the management team. Carefully considering how each factor affects the bottom line is fundamental.
Companies must be best-in-class. They must be widely recognized for their leadership in managing their businesses, serving their customers, reporting to shareholders, working with stakeholders and upholding sound environmental and social practices. Such companies are more likely to have the resources and reputational capital to succeed throughout the economic cycle. Firms must be built around sustainable business models. Among other things, investors should evaluate core capabilities, the value proposition of the product or service, and the target customer to determine long-term viability. Indicators, such as the eight-year-old Dow Jones sustainable index, reveal companies excelling in these kinds of measurements are likely to make a good long-term investment.
Some of the larger socially responsible funds have adopted this approach. But all told, they represent a small percentage of retail funds in Canada. To enter the mainstream, these funds will need to be developed and distributed by the banks, because they are the ones with the resources needed to ensure critical mass; much as banks' mutual funds enabled average Canadians to participate in the market.
By doing so, investors will both benefit from an emerging investment theme and help fund the companies that will address the pressing environmental challenges. We have the opportunity to realize the words of Mahatma Gandhi and "be the change we want to see in the world."
Green is good as long as investors treat the theme as they would any other designed to achieve their long-term financial goals. Nothing will be gained by losing sight of sound investing principles.