Making your investment portfolio more sustainable: a step-by-step plan
January 05, 2023
8 minutes to read
Looking for (greater) returns? Want to make a difference in the world? Or is it just time to revitalise your tired old portfolio? Whatever cause or reason you have to make your investments more sustainable: in just a few steps you can be fully up to date again.
Step 1: What does sustainable investment mean for me?
The first step is to identify your personal values and priorities.
Sustainable investment does not fit neatly under one label. Your idea of what sustainability does or doesn't involve will mainly determine the final shape of your portfolio.
The easiest way is to choose a strategy that comes closest to your convictions. Some popular strategies at a glance:
- Apply exclusion criteria. This means that you do not include, or you remove certain companies, industries or sectors from your portfolio. Typically, these are companies or sectors related to fossil fuels, aviation, alcohol, tobacco, weapons and gambling. Naturally, you decide for yourself how far you want to go; a classic dilemma is oil companies that have started investing in renewable energy or CO2 storage. One investor will exclude them because a large part of their turnover is still derived from oil. The next will invest in them to support their transformation.
- Apply ESG criteria. ESG stands for Environmental, Social and Governance. This means that you only invest in companies that achieve a certain score on aspects relating to the environment, society and good governance. What matters here is that these three factors are in balance. For example, investing in a wind turbine manufacturer can be good for the climate, but if child labour is involved, rainforests are felled for balsa (a type of wood used in the blades) and the manufacturer bribes governments, this can no longer be described as responsible investment. This strategy allows you to select companies based on a best-in-class approach. You are only investing in the companies or sectors with the highest scores.
- Impact investment. This is the "deep green" form of sustainable investment. You only invest in companies that have a real and measurable positive impact on people, the environment and society. Instead of negative selection, you opt for positive selection, where you invest in companies that promote sustainable practices. This would include investing in companies that create solutions to reduce the waste mountain or develop alternative sweeteners in the fight against obesity.
So far, we have described sustainability from a selfless point of view: “I don't want my investments to be detrimental to society or the environment”, or “I want my investments to have a positive impact”. You may alternatively – or in addition – invest sustainably to reduce your own risk. Simply put, companies that don't really care about the climate risk losing customers. Companies that treat their employees poorly risk social unrest. Companies that evade taxes risk fines. By investing in a more sustainable way, you may therefore also be less exposed to risks that may adversely affect your return.
Step 2: check which items in your portfolio are still aligned with your principles
Once you have established how high or low you want to set the bar and which strategy you want to follow, it is time to screen your portfolio and discover what is lurking under the bonnet.
- Shares. Depending on your sustainability preferences, there are various ways to assess whether or not a share deserves a place in your portfolio. If you have enough time, you can take a critical look at the sustainability reports and information on the company’s website and reach your own conclusions. However, it is much easier to access one of the many data platforms that calculate companies’ ESG scores. This allows you to see at a glance what kind of animal you have in your sights. Some examples:
- MSCI. Their public search function for ESG ratings and climate impact allows you to browse more than 2,900 companies which together make up the MSCI ACWI Index.
- Sustainalytics. In their database you will find data for more than 14,600 listed companies. You can also see how well a company scores compared to other companies in the same sector.
- Refinitiv. ESG ratings for more than 10,000 companies have been freely available since 2021. For each company you will find an overall rating, a rating per area (E, S and G) and a score per category within each area.
Note that these ratings are based on a proprietary methodology, not on a universal standard. Therefore, take the scores with the necessary dose of caution and check out how the methodology works. It is therefore quite possible for company X to have a score of 91 in one and 68 in another. The neutrality of the figures should improve over the next few years because – at least at European level – standardised sustainability reporting for companies is being rolled out.
- Bonds. For bonds, the story is rather more complicated. As environmental, social and corporate governance criteria can be applied and analysed for shares, this should in theory apply equally well to corporate bonds and government bonds. There do also exist sustainability indicators for these, but unfortunately these datasets are not yet accessible to private investors, or are more difficult to access. There is therefore little choice but to do your own analysis. It is also important for sustainable bonds – green bonds, blue bonds (water-related investments), climate bonds, etc. – that you investigate for yourself exactly what happens to the money invested.
- Mutual funds. In the past, funds were more or less free to label themselves as "sustainable", "green" or "ethical". This is now no longer possible. The investment policy for each fund –which can be found in the KIID – and on the fund company's website now also contains information about the sustainability policy it follows. This will make it much easier than before for you to assess whether a product meets your sustainability expectations. Here, too, it is important to maintain a critical view. Some fund managers use their own methodology, where they refer to a mix of all kinds of different sustainability criteria and indices. The fact that actively managed investment funds are not always totally transparent about the companies in which they invest also makes it more challenging to form an independent opinion. With passively managed investment funds (trackers or ETFs) which track an index, you do know exactly which companies they invest in.
Step 3: What alternatives are available?
Now that you have identified your individual priorities and analysed the sustainability of your portfolio, it is time to ring the changes.
You probably do not only invest because you want to nudge things in the right direction. You probably also want to earn some returns. Alongside your preferences in terms of sustainability, your preferences in terms of risk and return continue to be (at least) equally important. So don't lose sight of them. If you are rather defensive and can't sleep at night if your investments fluctuate frequently, it may not be a good idea to invest everything in renewable energy shares.
One way is to screen and buy individual securities yourself. You can do this using the tools in step two (but don't trust them blindly). If you don't have the time or inclination to screen equities and/or bonds, then trackers and/or investment funds might be an easier alternative. You don't have to do the homework yourself, and with these products you can invest in dozens or even hundreds of companies in one fell swoop. On the other hand, you still need to check whether the sustainability criteria and filters used match your preferences.
Looking for ideas for sustainable investment funds? On towardssustainability.be you can select funds by using the search engine, based on various criteria. Another alternative is Morningstar’s ESG screener.