How to choose your Sustainable Portfolio
Choosing your investment portfolio is a difficult decision.
Choosing a sustainable, value based portfolio adds another level of decision making.
Don't let complexity stop you from investing sustainably!
We're going to cover a number of topics in this article. Because of the sheer volume of information to talk though, I'll just give a few bullet points and links to more detailed thoughts as needed.
I'm going to break this article down as follows. Feel free to click the links below and jump around.
Background Information
How to Information
Diversification and Asset Allocation
Two of the main aspects of developing an investment portfolio are diversification and asset allocation.
Diversification = Don't put all of your eggs in one basket.
In order to reduce your level of risk, you can buy multiple companies or funds to reduce the risk of "single company failure."
Asset Allocation = Don't diversify all within one sector.
You could properly diversify by buying 20 different stocks. But if all of those stocks are still in the same sector (real estate or tech for example), you haven't effectively reduced your risk that the specific asset class will lose money.
Below is an example of a diversified portfolio.
This couple is roughly 70% stocks, 30% bonds and cash.
On the right side of the pie chart, you'll see they have money in a number of different sectors.
WHY IS THIS IMPORTANT?
When you build a portfolio, you can reduce your risk by buying Non-Correlating Asset Classes.
Asset classes that zig when others zag.
A good example of this is US stocks and 20 year US Treasuries.
When stocks plummet, there is often a "flight to safety". As in, investors sell out of their stocks, and buy "safe" 20 year US Treasuries. This can cause their price to rise during down markets.
In a portfolio, here's what that looks like...
US Stocks
Int'l Stocks
Global Real Estate
20 Year Treasuries
US Bonds
Global Bonds
TIPS
Munis
Notice how the top three asset classes are down 11-21% while the highlighted three are up 4-21%?
This is what non-correlating asset classes do.
This eliminates some "risk" in your portfolio and smooths out your investment "ride."
Active vs. Passive Investments
This is a topic all in itself. I'm not going to go too in depth here. If you'd like to learn more check out my Ultimate Guide to ESG Investing, Active. Vs Passive Section.
I am a firm believer in passive (low cost index) investing over active investing. There are a number of reasons why but it really boils down to:
I have seen enough evidence to show that active managers rarely beat their index NET OF FEES, over a long time period.
Thus I believe passive, low cost investments are a better option for most people.
But...
I actually believe that for a sustainable investor, active investments can be a better option.
To explain my thoughts, here's a quick "history" of investments. (bear with me on this) - To skip the history lesson, click here.
We started with:
Individual Stocks -
Early on, this was our only investment option.
Then...
Actively Managed Mutual Funds -
You pooled your money with other investors to buy a "basket" of stocks or bonds.
A manager bought and sold the stocks for you.
Then...
As stock markets became more efficient, IE, more data was publicly available, actively managed mutual funds slowly lost their edge. (my opinion)
With the rise of instant and transparent information, the Efficient Market Hypothesis evolved which stated that a company's current stock price accurately reflected all of the relevant public data.
Therefore, it's very difficult to "outsmart" the market. IE, Buy an index Fund.
Along comes Jack Bogle, founder of Vanguard Investments.
The father of the Index Fund.
Index funds fit perfectly into the Efficient Market Hypothesis.
As of 2019, index fund assets have surpassed actively managed mutual fund assets.
1
To view this slightly different...
Individual Stocks >> Actively Managed Mutual Funds >> Index Funds
Why all of this matters with sustainable investing...
I give you this history not to bore you, but to give you context.
I believe that since sustainable investing is "newer" on the curve of investing, there is still potential for out performance with an Actively Managed Mutual Fund.
Here's why:
Remember that Efficient Market Hypothesis?
The idea is, it is hard to beat the S&P 500 index (for example), because a company's financial data is public information and therefore available to the millions of investors out there.
IE, you can't outsmart the masses because they have access to all of the relevant financial information.
This is VERY IMPORTANT to understand because this is key. I'll say it again...
IE, you can't outsmart the masses because they have access to all of the relevant financial information.
Now... Think of these brands.
What do they have in common?
They are innovators.
Their customers are extremely loyal.
They value People over Profits.
These companies may be built on a solid set of ethical values instead of a "profit first" motive which can occasionally lead to scandals.
How do you accurately value their goodwill?
Their loyal extremely customer base?
How do you value industry innovation?
You can't easily value these non-tangibles, this Non-Financial Data.
This is why I believe actively managed sustainable funds can still provide an advantage over passive sustainable index funds.
An effective fund manager can exploit this Non-Financial Data to potentially outperform the market.
How to build your ESG Portfolio
A few disclaimers:
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I am not recommending any specific investments.
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My intent is to show you some tools that you can use to build your own portfolio.
We are going to use the US SIF list of sustainable funds.
Step 1) Grab your portfolio spreadsheet here.
You don't need this spreadsheet, but feel free to grab a copy if you find it helpful.
We'll be filling in these asset classes.
Let's first talk through a few of the categories on this list to help you in your next steps.
Fund Type - This is generally going to be your "asset class".
You can filter this by clicking on the "View by Fund Type" drop down.
Inception Month - Generally, the longer a fund has been open the better.
In the mutual fund world, not all funds survive long term. You want to find a fund (ideally) with at least a 5 year track record.
3, 5 & 10 year Avg % - This is the funds average performance over the corresponding time periods.
I would suggest that you ignore the 1 year number. Give little weight to the 3 year number and pay attention to the 5 & 10 year numbers.
Any fund manager can get lucky and outperform the index over a 1 year period. A true test of a managers value is their ability to have a long term consistent track record.
AUM - Assets Under Management.
Bigger is better.
This doesn't mean if the fund has more assets it will perform better, it just means that more people have invested into the fund.
Think if Bill Gates were raising money from investors for a new venture. The more money he raises, the better his chances of success (theoretically).
Compared to your cousin Vinnie who is also raising money for his third startup business in four years. He may have a winning idea, but if he can't get sufficient assets, his idea may not last long term.
Expense Ratio - The lower the number the better.
Standard Deviation - This means, during the majority of market cycles, you can expect a return + or - the standard deviation.
With this fund for example, it would be completely normal for your returns to be anywhere between -12.25% and +12.25%.
The higher the number, the more volatile the fund will be but it will also have higher Expected Returns.
A caveat to expense ratios:
Above you'll see the same fund with C, A and I shares. All with correspondingly (different) expense ratio's.
Normally any investor can buy A or C shares (these carry some type of sales charge).
The I means Institutional. You have to check with your custodian (where your investment account is held) to see if you can purchase these shares.
Supplemental tabs:
I'm not going to explain these here, just know they exist if you prefer to dig deeper, this is where you can do so.
Note - You can also use other online screeners such as Fossil Free Funds, but I like the layout of the US SIF screener so we'll use this.
Are you ready to build your portfolio??
Bring back your Portfolio Spreadsheet, and filter the US SIF Results by your asset class.
We'll start with "Equity Large Cap", filter by clicking "Exp Ratio %" and then scrolling to the bottom.
Since we know that all of the funds on this page have the lowest expenses. We'll start to circle "trends."
Green are "best"
Orange is "next best"
Based on this quick look, Praxis Growth Index Fund & Calvert US Large Cap Core Responsible Index look pretty good.
You could make a decision based on your gut at this point, or do a bit more of your own due diligence on these two funds to make a decision.
From here, you'll want to continue down the asset class list and fill out the spreadsheet.
Disclaimer: The above portfolio is NOT A RECOMMENDATION. This is simply a quick pass through the US SIF fund list and choosing some of the funds that stood out in each category.
In each category, there are multiple funds that would fit. But I wanted to have some investments chosen so I can show you a few things.
1) You'll notice on the bottom the Weight Average Expense Ratio.
Expenses are very important in a portfolio. So as you're choosing your investments, you may be shocked with the Pax Global fund at 0.97% or the Saturna Sustainable Bond fund at 0.89% expense ratio's.
Remember, these are only a part of your portfolio. When you add all of the components together, your average expenses will be lower.
2) You'll see 50-100 on the top of the spreadsheet. This is the Percentage of Stocks.
For example, 80 means 80% stocks (and 20% bonds).
The vast majority of my clients are anywhere between 60-80% in stocks.
If you go much below 60%, I feel you're being a bit too conservative.
If you go above 80% in stocks, you gain a noticeable amount of increased volatility for a negligible amount of increased expected return.
Step 3) Implement your portfolio based on the percentages in each asset class based on your risk tolerance (50-100% stocks)
Key Takeaways
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Focus on trends. Look for funds with a trend of early inception date, higher returns than it's peers and low expenses.
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Don't sweat the details. A "good enough" portfolio that you actually implement is better than a "perfect" portfolio that never gets finished.
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You can always refine and tweak your portfolio with time.
Additional Resources
Check out the Ultimate Guide to ESG Investing.
EFT.com has a list of ESG ETF's.
Here is a Spreadsheet with many of the most common ESG ETF's as well as their ratings from Fossil Free Funds and their affiliate sites.
*I don't know how often this data is updated and can't vouch for it's accuracy.
Invest with Values - This site offers a good directory with a number of resources to guide you towards answers to many green living questions.
If you are interested in learning more about ESG Investing, but don't know how to get started feel free to schedule a phone call. We're happy to help...
We're a different kind of financial firm than you may be used to.