Ethical vs ESG: Can You Teach An Old Dog New Tricks?

Traditional ‘Ethical’ portfolios tend to exclude or include certain companies based on even the smallest infraction or exclude all companies within a particular industry because of the industry’s environmental record—irrespective of each company’s specific policies and practices. This binary and rigid approach can lead to a smaller investment universe, a diminished opportunity for diversification and generally results in higher costs.

By contrast, Betafolio ESG aims to allocate more to companies that adhere to higher sustainability standards and less to those that don’t, while maintaining our low-cost, buy-and-hold and globally diversified approach that has been demonstrated to serve investors well over the longer term.

Often this approach is referred to as “light green” ESG investing. Yet it is borne out of the acceptance that ESG investing isn’t black-and-white. It is more of a balancing act. Since environmental business practices can vary considerably among companies, corporate governance and practices that advance sustainability are better characterised along a spectrum. We believe that an investment methodology that applies more robust sustainability scoring at company level, rather than a blanket ban on an industry or sector, may better serve investors.

The United Nations describes sustainable development as

Development that meets the needs of the present without compromising the ability of future generations to meet their own needs. (1989)

Whereas traditional financial analysis considers only quantitative financial and economic data, Environmental, Social and Governance investing attempts to incorporate non-financial factors into the investment decision making process. The goal of Betafolio’s ESG portfolio range is to place greater emphasis on companies that are adhering to higher sustainability standards while maintaining our low cost, buy-and-hold and globally diversified approach that has been demonstrated to serve investors well in the long term.

Fund managers use a variety of techniques in order to construct ESG portfolios. The more rudimentary construction methods involve excluding firms based upon their participation in the production of certain products, for example, munitions and tobacco. More complex construction methods include the use of ESG ratings in conjunction with share indexes, whereby a certain percentage of the lowest scoring firms are either removed or are weighted less heavily within the fund than their market capitalisation within the share index would suggest.

Source: Vanguard ESG SRI and impact investing (2020)

ESG IN FIXED INCOME

While ESG investing for equities is widely established, it is less so for fixed income.

The Betafolio ESG range was upgraded in early 2020 with the addition of a sustainable fixed income fund. Previously, this was not possible due to the minimal amount of funds in this space along with their high costs - this did not fit in with our low-cost philosophy.

The new Dimensional Global Sustainability Fixed Income Fund takes sustainability considerations into account through a combination of fund-level exclusions and sector-level weighting designed to reduce exposure to bonds issued by companies with less sustainable business practices. Issuers are ranked by an environmental score based on greenhouse gas emissions intensity, land use and biodiversity, toxic spills and releases, operational waste, and water management. The lowest-scoring issuers are generally excluded from investment. It also considers that some issuers are not high greenhouse gas emitters but may enable future emissions by selling fossil fuel reserves for consumption. Generally, issuers with the highest potential emissions from reserves are excluded.

Source: Dimensional Sustainability Report (2020)

Betafolio’s ESG portfolio range includes a number of ESG funds, included after a thorough analysis of the underlying fund construction process utilised to ensure their ESG credentials. In addition, all funds fit Betafolio’s core investment philosophy of being low-cost, passively managed and maintain a diversified market capital approach.

Appendix A - Negative Screening

Vanguard ESG Developed World All Cap Equity Index Fund Methodology


Exclusionary issue

Restriction – Companies that:

UN Global Compact

Anti-corruption

Violate the UN Global Compact Principle

opposing corruption in all its forms, including extortion and bribery

Environment

Violate the UN Global Compact Principle on environment

Human rights

Violate the UN Global Compact Principles on human rights

Labor standards and health and safety

Violate the UN Global Compact Principles on labor standards and health and safety in their operations or supply chains

Vice companies

Tobacco

Produce tobacco products

Adult entertainment

Produce adult entertainment

Alcohol

Produce alcoholic beverages

Gambling

Participate in gambling-related business activities, including casinos, online gambling and racetracks. 

Weapons

Controversial

Produce or manufacture cluster munitions, land mines, chemical or biological weapons, and nuclear weapons

Conventional

Produce or manufacture conventional military weapons and firearms

Civilian Firearms

Produce firearms or ammunition for non-military use

Non-renewable Energy

Fossil Fuels

Have revenues arising from the production

of petroleum or coal mining, or proven reserves in oil, gas, or coal

Nuclear

Own or operate nuclear power plants, or uranium mines, or supply essential goods or services to the nuclear power industry

a

Dimensional Funds plc Global Sustainability Core Equity Fund Methodology

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