Only Want to Invest in Companies That Can Meet the Paris Accords Guidelines? We Did That For You
When we built our new SRI funds, we thought they were good. But we wanted to know for sure, so we hired a firm to find out. The results exceeded our expectations, and showed us how responsibility should be measured.
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OK, so you know about SRI funds. (You don’t? Check this out and you’ll get it.) One of the three most important letters in SRI (or Socially Responsible Investing) is R. Maybe the most important letter. When you decide to invest in a way that does the least amount of harm possible to the world, you put your money in an SRI ETF. And when you do, you want to trust that the fund is putting your money to work in a way that’s, well, responsible.
But not all SRI funds are very responsible. A lot of SRI funds are, in fact, slightly irresponsible — and include companies that are in no way environmentally friendly, like major oil producers. Even ours fell into this camp until recently. The SRI funds that Wealthsimple used to invest in weren’t terribly strict about which companies it included, so we made our own funds. (You can read about them here.) But how good are these new ones, really? And how do you even measure the efficacy of such funds? We hired an independent firm to audit the overall carbon emissions of the companies we invest in, so we could have a full picture of how eco-friendly our ETFs actually are.
We sat down with Ben Reeves, Wealthsimple’s Chief Investment Officer, and asked him to explain.
How do you measure the environmental impact of an ETF anyway?
Well, one way is to have a climate benchmarking firm take a look at the emissions and the climate-related risks of the companies you hold in your ETFs. Which is what we did with our SRI funds, the Wealthsimple North American Socially Responsible ETF and the Wealthsimple Developed ex-North America Socially Responsible ETF. The company, ISS, gave us a report that outlined these exposures. To do this, ISS looked at the emissions of each company held in our ETFs — including the emissions caused by direct activity and by the company's energy use. When you add up these values, you get a company’s carbon footprint, which you divide by its sales to get its carbon intensity.
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Do other SRI ETFs have this sort of data? I’d love to see it all lined up.
Some do, but most SRI ETFs rely on what are known as Environmental, Social, and Governance (ESG) scores, which are based on all sorts of criteria. The trouble is that ESG scores are not particularly meaningful or reliable. One ratings agency will give a company a favourable ESG rating, while another agency will score the same company low. We chose to screen our fund based on the actual activities and emissions of companies, and report using hard data.
So how did the Wealthsimple funds stack up against other SRI ETFs?
The North American Socially Responsible ETF scored in the bottom 25th percentile of SRI ETFs when it came to carbon intensity, which is great and makes it one of the most environmentally-friendly ETFs. On average, each company in that ETF produces 28 tons of carbon for every million dollars in sales it earns. Wealthsimple’s ex-North America Socially Responsible ETF scored even better, with companies averaging 22 tons of carbon per million dollars in sales. The typical company in a broad, North American non-SRI index, in comparison, produces about 129 tons of carbon for every million dollars in sales; some other big SRI funds we looked at weren't much better, with companies that produce 100 tons of carbon per million dollars — not good.
Why did Wealthsimple’s ETFs do so well?
Partly because, instead of investing in the least-dirty companies in dirty industries, like other SRI funds do, we avoid dirty companies altogether — like oil and gas-related firms, and companies involved in coal mining or coal power generation. We also don’t try to match a market-cap weighted index, like the S&P 500, which causes many SRI ETFs to invest in companies that cause a lot of environmental harm. Our portfolio, in contrast, comprises companies that are aligned to the most aggressive climate-change target of 1.5 degrees Celsius increase over pre-industrial temperatures.
Which kinds of companies have high emissions and which ones have low emissions?
Companies that produce or use a lot of fossil fuels tend to have high emissions, like oil companies or airlines. Companies with lower emissions tend to use less energy, like technology or healthcare companies.
Are there types of companies that I might think have surprisingly high emissions?
Agriculture, because of things like methane from livestock, and real estate, because of inefficient buildings. Consumer goods is another sector with high emissions; it takes a lot of carbon to manufacture and ship clothes and processed food.
There are a lot of SRI ETFs out there. What prompted you to create your own?
We saw a few flaws in the funds we had been investing in — they were using inconsistent methodologies to rate companies, and, as a result, they included companies that didn’t share our values, like weapons manufacturers and fossil-fuel producers. But, when we looked around for other, better funds, we didn’t see any that were stringent or transparent enough for our liking. So we made our own. We used extremely strict environmental activity screens — like omitting all fossil-fuel producers and the top 25% of carbon emitters in each industry — and screened for social and human-rights issues. We were so demanding about the kinds of companies that we would include that we couldn’t find enough companies to make a strictly Canadian diversified fund, which was our intent. So we added some U.S. companies — that’s why we call it a North American ETF. As a result of our screening, our funds are aligned with temperature-change goals of the IEA Sustainable Development Scenario (SDS) and the Paris Agreement.
So was the audit meant to measure how successful you were in building a better SRI ETF?
We actually did these audits because an activist group emailed and asked what our carbon footprint was. We didn’t know, but we thought it was a good question, so we went and found out.
It’s great that the SRI ETFs performed well in the audit — but how do they perform at making money?
Good question. Our screens for social responsibility have detracted some from performance, but the risk management techniques we use to select and weight stocks have more than made up for that so far. Our ETFs haven’t been around long, but our North American fund has tracked with the non-SRI index, while the ex-North America fund has outperformed it by about 8% since inception. Still, in the long run, we believe that investors shouldn’t expect to significantly out- or under-perform by investing in SRI funds.
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If you’re so good at making ETFs, why not make more?
We’re working on it! We approach making ETFs like investors: when we see gaps in the market, we invest. We have a couple of more SRI ETFs planned. We hope to announce something in the next month or two that we are excited about. But we’re not ready to announce yet.
You’ve spent a lot of time thinking about SRI portfolios. Do you think investing in SRI funds is the best way to affect environmental change?
When you invest in a good SRI fund, you are making sure that you don’t profit from companies who are most actively hurting the environment — or engaging in other social practices that you might find undesirable. But, for my money, the most effective things you can do to help environmentally are:
Change your own behaviour.
Lobby companies to change with your consumption dollars, e.g., don’t spend on dirty products.
Elect political leaders who will set the conditions to improve the climate.
Donate to groups that aim to improve the environment.
Data provided by ISS ESG. All rights in the data provided by Institutional Shareholder Services Inc. and its affiliates (“ISS”) remain with ISS and/or its licensors. ISS makes no express or implied warranties of any kind and shall have no liability for any errors, omissions or interruptions in or in connection with any data provided by ISS.
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