Anecdotally, ESG is becoming a larger part of wealth managers' conversations - particularly with the growing mass of millennial investors. Lyxor ETF takes a look at how investors can take a passive stance on ethical investing.
Ethical investing is back in the limelight this year. According to the Investment Association's September data release, the Ethical funds manage over £14bn in the UK: an all time high. But for a long time, ethical portfolios have been challenged- dominated by high cost equity portfolios which could be highly concentrated. For controlling risk and cost, ETFs could be a solution.
Morals don't end at your chequebook
Socially responsible investing (known as SRI) is not new, but the concept is going through a revival. Part of the push for ethics is structural - there is more pressure on trustees and pension funds to consider ethics within their portfolio. But another part is ground upwards push. The individual who cycles to work, buys organic and donates to charity does not want to switch off their principles when it comes to their savings.
A testament to big data
Historically SRI was seen as a preserve of active investors. It took a professional to read reports, talk to mangers and decide which companies were doing good. This was laborious and as a result, many the funds suffered under the burden of high fees.
But in recent years, index providers have built up their databases to include ESG criteria. In turn, this has allowed them to construct ethical indices and has facilitated the launch of ethical passive investments.
In theory, socially responsible companies could be a better bet than traditional firms. More ethically minded companies might avoid fines and censures. Companies burning fossil fuels not only pollute more, but their business costs can be volatile - as commodity market swings have shown.
However, the reality has been more complex. SRI funds have often been concentrated in just a few sectors, which means they've had periods of underperformance and periods of strong outperformance.
And diversification is a problem beyond sector concentration. A large proportion of ethical funds are equity based. This leaves an individual with the challenge of how to balance their portfolio.
A new asset class could yet become a staple for ethical portfolios. Green Bonds are issued by companies or entities who want to finance environmentally sustainable benefits. They are generally infrastructure targeted, and certified to ensure they remain "green".
A green bond might finance a company's efforts in energy efficiency, renewable energy, clean water, river/habitat restoration, acquisition of land, mitigation of climate change impacts. A good recent example was SNCF, the French train network. They raised money to finance "Eligible green projects" - including maintenance, upgrade of energy efficiency of the train system, adding new public transport routes. They raised EUR900m in October 2016 and the issue was oversubscribed (EUR1.5bn in orders overall).
From an investors' point of view, they're one of the first proper SRI fixed income options. The bonds are traded and priced on their merit - so this is an alternative to buying traditional fixed income investments. You're not going to pay extra (get less yield) just because it's supporting green initiatives.
The world's first Green Bond ETF
Lyxor launched the Lyxor Green Bond (DR) UCITS ETF (CLIM LN) in February. It is a diversified way to invest in green bonds, covering over 110 government and corporate issues. The index is constructed so that it only ever buys investment grade issues, each one approved for inclusion by the Climate Bonds Initiative. With ongoing charge at 0.25%, you won't be paying a premium.
Sources: Charges correct as at 20th November 2017. Ethical sector data from Investment Association's September 2017 data release, table 14. Green bond market data compiled as at February 2017.
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