What Is Sustainable Investing – the BS Meter
THE DEFINITIVE GUIDE TO SUSTAINABLE INVESTING - PART 3
This article is part of Bankeronwheels.com definitive guide to Sustainable Investing.
There are four main types of sustainable investing. Below, we explain why we think differently than most. By doing so, we can try to exclude what’s the most intrusive part of Sustainable Investing – the ESG Ratings. Now, let’s look at how, despite the irrelevance of ESG Ratings for impact on the planet, you can still invest in a socially-responsible way.
KEY TAKEAWAYS
- Screening of investments has existed for centuries. It’s simple to implement by removing investments not aligned with your moral values.
- Such investing is called Socially Responsible Investing or SRI.
- Wall Street made SRI complicated by blending it with exclusions based on ESG ratings that are irrelevant to the goal of most individual investors willing to protect the planet.
- SRI & ESG blends represent the vast majority of options, but pure SRI ETFs are also available.
- Finally, there is also a good choice of Impact funds, but these are more active investments.
Here is the full analysis
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- Get Rich, Slowly but Surely – We designed Equity ETF selection frameworks and then picked the best funds in each category, so you don’t have to.
- Become a Passive Investing Ninja – Have no mercy for Financial Institutions. Cut TERs, Taxes, FX Fees and Invisible Costs.
- Licence to Yield – Which Bond ETFs for your goals? How do price change? Should you hedge currencies?
- Don’t get fooled by Wall Street – ESG Ratings are not designed to protect the planet. Adjusted for risk, ESG ETFs will also inevitably underperform. So how can you invest Sustainably?
From Bankeronwheels.com
Beat Most Investors with FREE ETF Master Guides
- Get Rich, Slowly but Surely – We designed Equity ETF selection frameworks and then picked the best funds in each category, so you don’t have to.
- Become a Passive Investing Ninja – Have no mercy for Financial Institutions. Cut TERs, Taxes, FX Fees and Invisible Costs.
- Licence to Yield – Which Bond ETFs for your goals? How do prices change? Should you hedge currencies?
- Don’t get fooled by Wall Street – ESG Ratings are not designed to protect the planet. Adjusted for risk, ESG ETFs will also inevitably underperform. So how can you invest Sustainably?
RUNNING SUSTAINABLE INVESTING THROUGH OUR B.S. DETECTOR
Reinventing the wheel
You probably knew it – Ethical investing isn’t something new. Judaism prevented followers from investing in immoral companies and Islam – alcohol or pork products. As ethically-minded investors, millennials want to eliminate investments that are in conflict with their beliefs:
- Financing Controversial Weapons
- Supporting Tobacco Companies or
- Investing in Alcohol Firms, to name a few.
Investing in a broad index but removing some controversial stocks is called Socially Responsible Investing, or SRI. Some of us may not mind that this may have a negative impact on returns (separate article). But Wall Street made it complicated.
Calling Wall Street's Bluff
You see, most ESG Ratings are irrelevant as it relates to protecting the planet. Worse, these ratings are almost always backwards-looking. They can’t predict corporate controversies. And yet, Wall Street bundled them together with SRI filters to make things less transparent. It finances the ESG Rating industry and justifies higher fees.
Maybe because investing solely based on ESG ratings, also called ESG Investing, wouldn’t attract as much money. Sooner or later, a website like ours would call Wall Street its bluff. Finally, there is the holy grail.
Highly concentrated bets, e.g. related to clean energy, sustainable agriculture or investments aimed at solving a social problem, e.g. an underserved community, are called Impact Investing. The real stuff. Something that may make a difference for the planet.
Our Sustainable Investing Framework - Spectrum of Investments
Our Way of Thinking about Sustainable Investing
In summary, there are two criteria when thinking about Sustainability:
- Whether there are SRI, or ethical / value-based security selections (#2 and #3 in the graph above)
- Whether there are ESG-rating involved (#1 and #2 above)
- The last one, Impact Investing (#4 above), is slightly different, as we explain below.
Killing Portfolio diversification
Now, you get the picture. SRI Investing on its own makes sense. Blending ESG + SRI mainly does when ratings have a relatively low impact on the security selection. Here, at Bankeronwheels.com, we emphasize that diversification is key to long-term investing success. Both ESG Rating exclusions and SRI screening impact diversification.
Of course, removing controversial investments with SRI through ethical / value-based filters reduces ETF diversification. But this is your personal choice. The problem becomes more pronounced when an ETF only retains, e.g. 25% of the highest ESG-rated companies in a sector, further impacting diversification. And here, no one asked you for your opinion.
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Most coaching participants come from the EU or the UK.
But we have consistent demand from all around the world. We provided coaching sessions to individual investors stretching from Argentina to New Zealand, or Guatemala to Japan.
A significant part of our clients are professionals in the Tech sector, Lawyers or Doctors that want to avoid costly mistakes when investing.
We also coach 25-30 year old young professionals that want to maximise assets for early retirement. We also have a large group of entrepreneurs that e.g. receive large lump sums after selling their company and want to invest it in financial markets. We speak to Crypto millionaires that want to reduce their risks.
Finally, some of our coaching clients are in their 40s or 50s and want to set up customised, income-producing portfolios or create Bond ladders for their retirement.
Most of the coached investors are in the 25–60 year old range.
Yes, some of our coaching clients have shared reviews on Google.
Some considerations are included below. For more details, consult your regulator’s website.
A financial coach is:
- Trained but not regulated
- Skilled at reviewing your overall financial situation and goals
- Able to help you develop a financial plan to achieve those goals
- Happy to discuss the pros and cons of various financial products but can’t recommend a specific one for you
- Comfortable working with anyone, whatever their situation
- Going to charge for their time
A financial adviser is:
- Regulated and authorised by the regulator to recommend specific products to clients or is independent and able to offer ‘whole of market’ solutions
- Often, going to charge an annual management fee, typically 1-2% of their client’s assets with initial fees on top.
We are proud to say that our coaching service has empowered a number of clients to reconsider their financial advisers’ offerings. From our clients’ feedback, in a number of cases, clients were overcharged, and offered unsuitable products, often due to conflicts of interest. However, this is not a rule. The best choice between a financial coach and adviser depends on an individual’s unique circumstances, including their financial literacy, time availability, comfort with managing their finances, and complexity of their financial situation.
Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
- How do I Invest – What are the pro and cons of investing with a Bank? Why should I diversify brokers?
- What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
- Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
- Benchmarking – What are educated investors doing in a similar situation to mine?
We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:
- Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
- Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
- Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
- Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
- Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks?
- Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
- Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to?
From Bankeronwheels.com
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We Help You Avoid Costly Investing Mistakes.
Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create coaching sessions. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide.
Most coaching participants come from the EU or the UK.
But we have consistent demand from all around the world. We provided coaching sessions to individual investors stretching from Argentina to New Zealand, or Guatemala to Japan.
A significant part of our clients are professionals in the Tech sector, Lawyers or Doctors that want to avoid costly mistakes when investing.
We also coach 25-30 year old young professionals that want to maximise assets for early retirement. We also have a large group of entrepreneurs that e.g. receive large lump sums after selling their company and want to invest it in financial markets. We speak to Crypto millionaires that want to reduce their risks.
Finally, some of our coaching clients are in their 40s or 50s and want to set up customised, income-producing portfolios or create Bond ladders for their retirement.
Most of the coached investors are in the 25–60 year old range.
Yes, some of our coaching clients have shared reviews on Google.
Some considerations are included below. For more details, consult your regulator’s website.
A financial coach is:
- Trained but not regulated
- Skilled at reviewing your overall financial situation and goals
- Able to help you develop a financial plan to achieve those goals
- Happy to discuss the pros and cons of various financial products but can’t recommend a specific one for you
- Comfortable working with anyone, whatever their situation
- Going to charge for their time
A financial adviser is:
- Regulated and authorised by the regulator to recommend specific products to clients or is independent and able to offer ‘whole of market’ solutions
- Often, going to charge an annual management fee, typically 1-2% of their client’s assets with initial fees on top.
We are proud to say that our coaching service has empowered a number of clients to reconsider their financial advisers’ offerings. From our clients’ feedback, in a number of cases, clients were overcharged, and offered unsuitable products, often due to conflicts of interest. However, this is not a rule. The best choice between a financial coach and adviser depends on an individual’s unique circumstances, including their financial literacy, time availability, comfort with managing their finances, and complexity of their financial situation.
Beginners often ask us:
- How do I reach my goals – What investments do I need to take into consideration for e.g. Taking a Sabbatical, buying a House or saving for Early Retirement?
- When should I invest – I fear that investing a lump sum in this market may have a negative impact on my returns. How can timing of buying ETFs affect my performance?
- How do I Invest – What are the pro and cons of investing with a Bank? Why should I diversify brokers?
- What should I consider investing in – What are some risks of portfolio diversifiers like Gold or Crypto?
- Avoiding Extra Costs – I have shortlisted a few ETFs, can you help me to compare them before I decide which one to buy?
- Benchmarking – What are educated investors doing in a similar situation to mine?
We are flexible. For example, answering some of these questions could help you avoid very costly mistakes:
- Challenging My Portfolio – Here is my portfolio – what am I missing? What could derail my strategy?
- Accelerating My Understanding – What are inflation linked Bonds? How are they different to Nominal Bond ETFs? What makes them outperform? Why do some investors add small cap value stocks to their portfolios? I want to exclude Tobacco companies from my portfolio – what are my options? What is Factor Investing?
- Simplifying Portfolio Maintenance – How can I diversify my investments? What is historically highly correlated so that I can consider removing it to keep my portfolio simple? How do I perform rebalancing? Does frequency matter?
- Reducing Risks – I want to understand the risks of investments – what are the different measures and how does it impact me? What are the risks of different types of brokerage accounts?
- Understanding the Impact of Recent Events – How do recent events impact my portfolio? What can I do to protect my savings from shocks?
- Investing Goals – I am investing for a specific goal e.g. Early Retirement, what is the research saying about e.g. the amount I need to have accumulated, how much can I withdraw annually? What are some calculators available and how to run them? What are the assumptions/shortcomings of these models?
- Comparing Equivalent ETFs – I have certain constraints in my tax-wrapper and can only select certain funds (e.g. I live in France and limited to specific synthetic ETFs). Which ETF characteristics should I pay attention to?
HOW TO THINK ABOUT SUSTAINABLE INVESTING
Planet Focus but avoiding ESG ratings
As you’ve seen, we developed our own framework for thinking about Sustainable Investing. But let us also make something clear. Pure ESG Investing (#1 on the graph above) shouldn’t be called sustainable investing. At least from a planet perspective. It is called like that because if you look at MSCI or Sustainalytics definitions, Sustainability is defined as… Sustainability of corporate profits.
Degree of Reliance on ESG Ratings and Value-Based Exclusions in Sustainable Investing
ESG RATING BASED INVESTING
1. ESG INVESTING
- Approach – Investing based mainly on selecting the highest ESG Ratings or excluding the lowest ratings.
- Reliance on ESG Ratings – ESG Ratings do impact ETF constituents. The ETF can eliminate e.g. worst performing (bottom 25%) or, e.g. retain only the highest (e.g. top 25%)
- Personal Values – The investor does not express her values
- ETF Landscape – ETFs focusing only on ESG Ratings are relatively rare
2. ESG + SRI BLEND
- Approach – Investing based on ESG Ratings and value-based exclusions.
- Reliance on ESG Ratings – ESG Ratings do impact ETF constituents. The ETF can eliminate, e.g. worst performing (bottom 25%) or retain only the highest (e.g. top 25%)
- Personal Values – The investor does express her values
- ETF Landscape – There is plenty of choice of ETFs in this category. That’s why we put the ETF icon in the framework graph. Unfortunately, it’s the trap/confusion zone for most investors.
NON-ESG-RATING BASED INVESTING
3. SRI INVESTING
- Approach – Investing based only on value-based exclusions.
- Reliance on ESG Ratings – Ratings marginally or do not impact ETF constituents
- Personal Values – The investor does express her values
- ETF Landscape – There is some choice of ETFs in this category
4. PASSIVE INVESTING
- Approach – No exclusions.
- Reliance on ESG Ratings – Ratings do not impact ETF constituents
- Personal Values – The investor does not express her values
- ETF Landscape – Wide choice
5. IMPACT INVESTING (Not Represented Above)
Impact Investing is not included in this graph because it takes a very different approach (separate article) But if we had to run it through our framework:
- Approach – Highly concentrated investments based only on planet/social impact goals
- Reliance on ESG Ratings – Financially-material ESG Ratings do not impact ETF constiuents
- Personal Values – The investor does express her values because it focuses on addressing a specific environmental or social issue
- ETF Choice – There is plenty of choice of ETFs in this category
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Different shades of 'Blend'
Of course, ETF selection is not all black and white. But without a robust intellectual framework, an investor can quickly get lost. The ESG/SRI Blend is the land of confusion. In the following articles, we look at these different shades of ‘blend’. Can you use value-based filters while minimizing ESG rating impact? Let’s have a look at the different benchmarks.
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