ESG is a must for retirement

Investors at every life-stage, early, mid-career, or retirees, need to invest sustainably

Andrew Willis 21 February, 2020 | 1:00AM
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With roots in religious compatibility - environmental, social and governance concerns of investors have grown into small forests of financial products. And it turns out, it pays to do the right thing.

Public interest is at a critical mass and the economy is changing. What started as a bandwagon has turned into a key investment strategy. As a result, more investors – and investment companies – are not only paying attention, but actively doing something about their investments.

“In 2019, 329 ballot items were voted on by shareholders of S&P 500 companies, of which 317 addressed environmental, social, and governance concerns. Of these, 151 addressed social and environmental concerns, of which 72 achieved at least 30% shareholder support – a significant outcome that attracts the attention of boards and management. Four S&P 500 index funds supported all 72 of these ballot initiatives,” points out Jackie Cook, director of sustainability stewardship research for Morningstar.

Looking at the direction in which things are headed, investors should get their portfolios in line with changing times, especially for longer-term goals like retirement. In short, no matter what stage of life you’re in, it’s time for responsible investing to be a requirement for your retirement portfolio.

Stage 1: Young investors – Growth focus
In some ways, young investors have already been reaping the benefits of ESG by following recommended routes and catching the attention of fund companies.

“I think if there’s any demographic of investors that responsible investing has resonated with, it’s millennials. There is an increasing awareness among younger investors across all letters: E, S, and G,” says Mark Raes, Head of Product at BMO Global Asset Management. 

John Bai, vice president and chief investment officer at NEI Investments agrees. “These are the impact investors who want to make things better.”

With this responsible investing evolution underway and a long runway ahead, it makes sense for young investors to get ahead of the movement by investing in an ESG fund. But will it give them the growth they need?

“The myth that you have to trade returns for ethics is exactly that – a myth,” says Tammy Cash, EVP, Marketing at Horizons ETFs. “For example, companies that are developing the green technologies of the future are likely to continue growing as we move toward a lower-carbon future and away from extractive industries."

Sectors like renewable energy will be in focus as attention and investment grows in the ESG space Bai says. “There’s a migration from rewarding short term [corporate] profits over long term growth creation,” adds Bai.

That especially makes sense for young investors, who have a long runway for investment growth. Young investors should invest more in equities for long-term goals like retirement, which neatly ties into the long-term nature of sustainable investing. You have a long road ahead and you’ll want the growth and diversification of a wide selection of stocks. This often means choosing broad index funds, and it turns out those same funds have already been developing ESG-positive personalities in shareholder resolutions, Cook notes.

Stage 2: Mid-career investors – Balanced focus
Mid-career professionals have begun building their portfolios, and are looking for faster, consistent growth. They need to protect their investments from market uncertainty, but also need to ensure steady income to sustain through their retirement years.

These investors could be considered what U.S. Chief Justice Leo Strine calls a “worker-investor” or the “99% [who] owe most of their wealth to their jobs” but who “do not benefit when some companies offload the costs of their activities, such as pollution and carbon emissions, on everyone else.”

Not anymore.

“Across 55 large fund families with more than US$17 trillion in assets, shareholder sustainability resolutions were supported 44% of the time – up from 26% in 2015 and increasing by 7 percentage points in each of the last two proxy seasons,” says Cook on what she calls a “global investor stewardship movement.”

This support of sustainable growth ensures that overall portfolio risks reduce, while generating returns. “We believe that integrating the analysis of environmental, social and governance factors with traditional investment analysis can improve returns but, more importantly, can help mitigate risks,” says Terry Dimock, Head Portfolio Manager at National Bank Investments.

Integrating ESG into a portfolio at this point could be seen as a transition, or as a complement, says Raes. Investors can start by addressing specific parts of the portfolio that have accumulated ESG risk – climate, labour, transparency, social issues - and then consider shifting any non-ESG balanced funds over to ESG balanced funds.

Stage 3: Retired investors – Fixed income focus
“These investors are ‘avoiding bad’ – the first thing that comes to mind is risk mitigation,” says Bai.

Longevity is the keyword here and it’s worth watching the leaders in this field: pension funds, who are investing heavily in ESG. “50 of Canada’s largest pension funds are signatories of United Nation’s Principles of Responsible Investing,” says Bai, adding that if you want to look at long-lasting legacies, look at signatory Canada Pension Plan and its 100-year horizon.

Though it may seem that ESG risks directly affect younger investors, the near-term risks to all portfolios are significant. The latest 10-year plans by our military are particularly concerned with climate change for example, notes Bai, “floods, fires, mudslides - climate change will affect demand and supply channels for major industries.”

Retirees shouldn’t be as exposed to volatility, and while it is recommended that they hold relatively smaller equity positions, it’s important to ensure those stocks they do hold will remain strong. Bai adds that he’s found “the worse the ESG rankings, the higher the volatility.”

When it comes to risk mitigation, particularly when considering the fixed income and the corporate bond route, Bai mentions a Bank of America Merrill Lynch study that found 90% of bankruptcies in the S&P 500 between 2005 and 2015 were of companies with poor environmental and social scores five years prior to the bankruptcies.

So how can retirees get sustainable fixed income? “Although options are still limited at this point, retail investors that want to “green” their portfolios can manage their way around. For instance, the Province of Québec offers Fixed-rate Green Bonds, through which retail investors can contribute to green projects with concrete environmental benefits,” mentions Catherine Maltais, Vice President, Fixed Income, Currencies and Commodities Group at the National Bank of Canada.

Bai says you’ll need some due dilligence when approaching bonds. It’s a nascent field and it can be challenging to ensure you’re getting the right return. “The best way to do it early is to do it together,” says Bai, noting an emergence of ESG fixed income with a wide array of stakeholder associations to keep your investment safe and impactful, “green bonds, blue bonds, education and social housing bonds,” there are many ways to make a lasting legacy for the foreseeable future.

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About Author

Andrew Willis

Andrew Willis  is Senior Editor at Morningstar Canada. He previously produced content for Fidelity Investments and finance industry events for Euromoney Institutional Investor and has written in the past for Thomson Reuters and CNN. Follow him on Twitter @Andrew_M_Willis.

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