Four Easy Steps to a Responsible Investing Portfolio

August 17, 2020

Four Easy Steps to a Responsible Investing Portfolio

08/17/2020

Jennifer Sireklove


Jennifer Sireklove, CFA

Managing Director,
Investment Strategy

More about this author

If you're just starting to think about becoming a responsible investor and don't know where to start, a simple checklist can work wonders.

Worried about climate change? Dismayed about gun violence? Concerned about the effects of opioids on individuals and communities? It’s not new for investors to think about how these issues connect with their investment portfolios. But the variety of tools and options to help make these connections is growing every day. That’s great news for investors who think about these issues—but it can make it hard to know where to start. 


We’ve found that when it comes to responsible investing, a simple checklist can do wonders. It can help investors move beyond intent to action and finally find the right stock or bond portfolio. Our checklist recognizes that sometimes investors just want to own good companies and avoid bad ones, by their own definition. Sometimes investors want bad companies to become better, which requires owning them. And sometimes a stock or bond portfolio just isn’t the right tool for the problem.


What is responsible investing?

Before we talk checklists, let’s talk acronyms and definitions—two other things that can stymie investors. The short story is not to worry about special terminology; an asset manager should always be able to explain it in plain English. But in case an investor finds themselves facing down a wall of acronyms, here are a few tips. 


The United Nations Principles for Responsible Investment (UNPRI) define responsible investing as solely focused on financial performance. Environmental, social, and governance (ESG) are the three broad categories used to classify the issues that responsible investors might think about. UNPRI distinguishes this approach from those with moral or ethical purposes, which have been typically associated with socially responsible investing, or SRI. That’s not to say that SRI investors don’t care about financial performance, of course, or that ESG investors are blind to morals and ethics. But those are the typical dividing lines. 

 

Investors might also have heard the term impact investing. This usually refers to investments made with the intention of generating measurable social or environmental benefits in addition to financial return. That may sound straightforward enough. However, an important concept in impact investing has been that of additionality: the idea that the benefit would not have occurred absent the investment. Although it has become popular to use the term impact investing expansively, investors may want to be aware that many still use the term in its more technical sense and reserve it for private investments in which it’s easier to prove additionality.

 

We try not to get too hung up on vocabulary; we’re happy to work with investors using whichever terminology they prefer. But these pointers have often helped new investors who crave context. With that cleared up, let’s talk about a responsible investing checklist.

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Step 1: List issues of concern

Investors should begin with a list of all their environmental and social concerns. Things we’re hearing a lot about from investors include things such as greenhouse gas emissionsgender parityplastics in the oceangun violence, and human trafficking. This list can be as long or as short as the investor wishes. The concerns can be very precise or more general. Getting them down on paper is a necessary part of the process.


Step 2: Determine which items pertain to the portfolio

Investors should next identify the issues on their list that are in scope for publicly traded corporations. Not all will make the cut. In the case of a publicly traded company, the concern should relate to the kinds of products that it sells or the way it conducts its business. Some concerns may qualify on that front but may be better addressed through public policy, such as regulating or containing plastic pollution. Other concerns, such as innovations in renewable energy, may be better suited for private companies or start-ups. 


Step 3: Identify active ownership opportunities

The next step is to circle the items where investors believe company behavior can be influenced—as long as they have the patience to try to see that change through. These concerns will form the basis of the active ownership practices they can use to push for corporate change—for example, voting in favor of shareholder resolutions calling for greater representation of women on a company’s board or reductions in greenhouse gas emissions. Investors need a portfolio that allows them to own the kinds of companies they seek to influence—a broad diversified exposure can be helpful—and ensure their asset manager’s voting and engagement activities support their desire for change. 


Step 4: Create a portfolio construction plan

Hopefully, this leaves you with a much shorter list of items that can be either easily mapped to a prebuilt portfolio or used to build a customized one.  The remaining issues should be relevant to public companies but not have realistic potential for corporate change. Using this list in your portfolio construction, investors can steer clear of companies that, say, sell tobacco while embracing companies that are, say, sharia-compliant. However, they’ll need to be willing to accept any potential tracking error or tax efficiency trade-offs that may arise from owning a somewhat different set of securities due to ESG criteria.


The bottom line

Being disciplined about figuring out what investors want to achieve as a responsible investor and how to get there is critical to determining the best approach for building a portfolio. It’s best to use ESG screens only when necessary and to use active ownership to influence company behavior. While it may take some work, the result will be a portfolio with the potential to bolster investors’ beliefs and their bottom lines.



 

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.

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