Sustainable investing is growing at a faster pace than any other segment within the investment community. Its rapid ascent can be attributed to the negative headlines about climate change, risks associated with artificial intelligence and machine learning, and rising income inequality.
To meet this demand, managers of existing responsible investment funds have expanded their scope to include environmental, social, and governance factors in addition to traditional quantitative screens for risk and value.
While there are currently more than 1,000 products explicitly marketed as “sustainable” available today – including ETFs, mutual funds, and hedge fund strategies – the management of these portfolios is ripe for further optimization.
That’s why we’ve compiled a list of helpful tips for building sustainably managed portfolios:
1. Ensure Compliance With Your Investment Strategy
Before you begin to build your portfolio, it is important to make sure that the funds you are choosing are in line with your fund’s investment strategy.
For example, if your fund’s investment strategy is focused on identifying companies that are reducing their environmental impact, you will want to make sure that the funds you are considering are actively screening for those factors.
2. Establish a Benchmark for Sustainable Investing
Before you begin to build your portfolio, you should consider establishing a benchmark for sustainable investing.
A benchmark is a tool that helps to evaluate the progress being made toward achieving your own investment goals. It can also be helpful for spotting areas of improvement that may have been overlooked. To build a benchmark for sustainable investing, you should consider your fund’s share of fossil fuel assets, governance scores, and percentage of renewable energy holdings.
3. Set Realistic Expectations
When building a portfolio of sustainable funds, it is important to set realistic expectations for portfolio returns. For example, if you want to invest in funds that are focused on capturing the growth of the low-carbon economy, you should expect to see lower returns than managers investing in the traditional fossil fuel economy.
4. Understand the Risks
Before you commit funds to your portfolio, you should understand the risks associated with your fund’s holdings.
To do this, take the time to read through the SEC-mandated risk disclosures for each fund in your portfolio. These disclosures can be found in a fund’s prospectus, and are usually organized around the following three risk factors namely, investment risk, credit risk, and liquidity risk.
5. Communicate With Portfolio Managers
One of the most important steps in sustainable investing is to take an active role in communicating with the portfolio managers who are actively investing your sustainable funds. Engage them and try to find out their expectations, the fund’s short- and long-term sustainable strategy, and their capacity to deliver.
6. Choose Quality Over Quantity
Investors often gravitate towards the largest companies because they’re the easiest to research, but this can cause you to overweight your portfolio in companies that are under-resourced for sustainability initiatives.
Instead, your investment portfolio should be made up of quality companies, not necessarily the ones with the biggest market caps.
7. Understand How Companies Are Operating Sustainably
While it is important to screen for bad actors, you also need to understand how well companies are operating sustainably. So, make sure that the companies you are investing in are actively and effectively executing their sustainability programs.
8. Be Mindful of Supply Chain Management Practices.
Some companies that are otherwise making good progress in their sustainability programs may be outsourcing production to suppliers who are sourcing materials in a way that is harmful to the environment.
This is particularly problematic in conflict areas like the Democratic Republic of the Congo, which is a hub for the production of tantalum, tungsten, tin, and gold. In situations like these, the investment fund manager has a responsibility to work with the company to encourage them to source from conflict-free suppliers.
Summing It Up
As the world becomes more conscious of the impact of human activity on our planet and its resources, investors are increasingly looking to invest in companies that are eco-friendly or offer products that reduce their carbon footprint. This has led to an increase in demand for sustainable investment strategies.
If you’re interested in investing in a more sustainable future, the tips above should help you build a sustainable portfolio that will not only perform better in the short-term, but also contribute to a more sustainable future.