investing

Responsible investment is an approach or strategy that takes into account governance, social, and environmental factors. Responsible investors acknowledge the fact that assets and businesses underperform when ignoring ethical, corporate governance, or social issues.

Environmental, Social, and Governance Factors

Responsible investment is about opting to invest in businesses that drive change, such as addressing public health issues and growing inequality, mitigating climate change, or improving labor standards. Examples of environmental issues that affect investment decisions are deforestation, pollution, waste, resource depletion, and climate change. Some of the social issues that impact the decision-making process are working conditions, child labor, modern slavery, and human rights. Corporate governance factors that can play a role in the selection of investments are donations and political lobbying, board structure and diversity, executive pay, and corruption and bribery.

ESG Integration

ESG integration is basically the inclusion of governance, social, and environmental factors in investment analysis. Issues such as the human resource policies, R&D, and product strategy of a company are analyzed, based on what issues the asset manager or institutional investor prioritizes. The extent to which the analysis is reliable and thoroughgoing depends on the values, sources of information, experience, and background of the analyst.

What Is Socially Responsible Investing?

Socially responsible investing refers to a diverse set of approaches that utilize environmental and social criteria when evaluating companies. Social criteria can cover a wide range of issues such as respect to gender and race, promotion and hiring practices, occupational safety and health, community welfare, etc. Environmental criteria can be things like:

Waste and recycling
Impact on natural resources
Raw material sourcing
Resource and energy efficiency
GHG emissions
Environmental management

Typically, investors score and select companies based on a set of chosen criteria. They first compile a list of qualifying companies and then evaluate their financial performance.

Thematic investment is a subtype of socially responsible investing whereby funds select companies that fall under a specific theme, such as climate change, pollution control, low carbon energy, or water distribution. A healthcare fund, for example, would invest in high-tech companies, nursing homes, health insurance providers, hospitals, and pharmaceutical companies.

Green investment falls under thematic investing and covers a variety of approaches that seek to support eco-friendly or green assets. These can include waste management, recycling, pollution control, and energy efficiency technologies, smart grids, low carbon vehicles, etc.

Impact Investing

Impact investing is a strategy that seeks to achieve a specific objective while generating financial returns. Such an objective can be supporting companies that hire persons with disabilities, companies promoting access to basic services such as education, healthcare, and housing, or projects providing employment to community members. Basically, the goal is to generate both positive environmental and social impact and financial returns.

Impact investors range from development finance institutions and family and institutional foundations to wealth managers, financial advisors, pension funds, and banks. The impact investment market has attracted a wide variety of institutional and individual players, including:

Nonprofits
Family offices
Insurance companies
Private foundations
Religious institutions
Diversified financial institutions
Fund managers

Socially Responsible Mutual Funds

These funds target and invest in companies that meet environmental, religious, moral, and social standards. They choose the securities that make up their investment portfolio based on both financial and ESG criteria such as policies aimed at fostering social inclusion, reducing poverty, or curbing the carbon footprint. Like other funds, they also seek to invest in companies with robust corporate government policies and strong balance sheets. The three main approaches that socially responsible funds utilize are impact investing, ESG integration, and value-based investing.

Typically, they target companies that employ and train disadvantaged minorities, promote responsible forestry, water and clean air conservation, or fight climate change. When looking into different mutual funds, investors typically account for factors such as experience, performance potential, risks, costs, and the extent to which the investment portfolios align with their values. There is a wide selection of socially responsible funds for investors to screen, a few examples being the SDRP S&P 500 Fossil Fuel Reserve, Vanguard FTSE Social Index Fund, and Parnassus Core Equity Investor. Parnassus, for example, excludes companies within the nuclear energy and fossil fuel sectors while the S&P 500 Fossil Fuel Reserve only targets fossil fuel-free companies. Vanguard eschews investments in companies within the gambling, alcohol, and tobacco sectors, civilian firearms manufacturers, and companies within the nuclear power and fossil fuel industries.

Socially Responsible ETFs

Socially responsible ETFs include a range of assets, including sector, international, and domestic equities. ETFs mainly invest in companies based on factors such as environmental and social impact. The iShares GNMA Bond ETF, for example, provides investors with the opportunity to promote affordable housing. The iShares MSCI ACWI Low Carbon Target ETF offers investors the chance to reduce their carbon footprint by investing in companies across a broad range of sectors, including real estate, energy, communication, and industrials, which are less dependent on fossil fuels. There are also ETFs with a focus on gender equity such as the SPDR SSGA Gender Diversity Index ETF, which invests in companies that help promote gender diversity. Another example is the iShares MSCI KLD 400 Social ETF which excludes companies that are involved in adult entertainment, military weapons, gambling, tobacco, and alcohol.

Socially Responsible Investing vs. Responsible Investing

While both terms are used interchangeably, there are some notable differences. Responsible investing refers to a broad range of strategies that consider both environmental and social factors and financial returns. The three main approaches here are impact investing, ESG integration, and socially responsible investing. With SRI, issuers or companies are excluded /negative screening/ or included /positive screening/ as investments based on environmental or social impacts. Positive screening might favor companies engaged in clean technology and alternative energy, environmental sustainability, or social justice. Negative screening, on the other hand, may mean eschewing investments in companies that have unacceptably high carbon footprints or a poor waste management record. Other negative screens may include labor violations, production of defense tools and weapons, gambling, tobacco and alcohol, and lack of diversity on boards. Exclusionary or negative screening is used to exclude companies within industries such as gas and oil and those that are contrary to international conventions and declarations. Common exclusions can also be:

Gross human rights violations
Nuclear power
Companies operating in a particular region or country
Hospitals or clinics practicing abortions
Companies operating in violation to international agreements such as the Rio Declaration on Environment and Development or the Universal Declaration of Human Rights.

1. Buying Real Estate

Investing in real estate may sound counterintuitive given that the average selling price is $688,000. Prices rose by 38 percent in 2020 alone. In most cases, Canadians looking to buy a home need to apply for a loan. As it turns out, however, the cost of borrowing decreases when wages increase and prices are on the rise. Average home prices are also rising faster than the consumer price index which makes investing in real estate a good hedge against inflation.

Additionally according to the Canadian Real Estate Association, home prices tend to be skewed by listings in expensive metropolitan markets such as Vancouver and Toronto. CREA tracks the house pricing index which gives a more accurate picture in terms of the types and number of properties sold.

2. Investing in Stocks and Bonds

There are investments that actually benefit from inflation, such being energy and retailers stocks. Energy companies profit when inflationary pressures are driven by oil price increases. Retailers also hike prices and considering the pandemic e-commerce boom, investing in e-commerce stocks can be a good idea.

Some equities both benefit and contribute to inflationary pressures, for example, metals, grain, lumber, and crude oil. It makes sense to buy shares in commodity companies either through mutual funds and exchange-traded funds or directly.

Investing in government bonds is yet another way to protect your money from inflation. What portion to dedicate to fixed income depends on how soon you will need cash and your risk tolerance. As a rule, government bonds offer income and security but the shorter the maturity, the lower the yield. That is because investors face less risk of interest rate increases. Bonds with longer maturity are more sensitive to interest rate fluctuations. The choice of shorter maturity depends on factors such as income requirements, nearing retirement, and the need to diversify investments.

3. Alternative Investments

The price of alternative investments such as silver, gold, and cryptocurrencies is also rising in the long run. As they are risky, dedicating a small portion to alternative investments only makes sense. At the same time, they are thought to not only retain their purchasing power but to outperform when inflationary pressures arise.

Also, there is a wide array of investment options to look into, besides bonds and stocks, each with its proposition, value, and risk factor. The range of solutions includes derivative contracts, commodities, antiques and art, managed futures, hedge funds, venture capital, and private equity.

The category of alternative assets is vast, indeed, but there are some factors to consider when building a portfolio. First, investors can choose to own assets such as farmland, commodities, precious metals, and real estate indirectly or directly. They can either buy physical assets or shares like, for example, invest in shares of gold or gold bars. The same is true for other assets such as real estate or farmland. When buying shares, the asset is tied to physical property, thus giving investors a choice between financial and physical assets.

Some alternative investments are classified as risky, such being the case with farmland. The value of farmland has steadily risen on an annual basis over the last three decades. There are no signs of slowing down in the short term, given the demand for commodities and agricultural products. In fact, farms will need to significantly increase production to meet growing demand as global population growth continues.

An alternative solution is to invest in inflation-linked bonds which are pegged to the consumer price index. In this case, the interest and principal rise and are adjusted for inflation. There are many benefits to investing in inflation-linked bonds such as less risk and volatility and higher returns compared to conventional bonds. A word of caution should be mentioned here, however. When deflation occurs, the bond principal will fall below par value, with interest due on the inflation-adjusted principal. Investors are likely to incur capital losses if deflationary pressures persist. The longer the maturity, the more vulnerable bonds become to interest rate fluctuations.

4. Portfolio Diversification

Building a diversified portfolio is an excellent hedge against inflation. The types of assets that can protect an investment portfolio against inflationary pressures include US stocks and REITs, treasuries, TIPS, commodities, emerging stocks, gold, European and Pacific stocks, and international REITs. Real estate investment trusts, for example, buy a diverse range of real estate that is rented out and produces solid returns. There is also an option to invest in international and US REITs and many have done so since the 2008 US market crush. The fact is that REITs invest in both commercial and residential real estate and are more diversified than conventional real estate portfolios. This means that they are more stable and less risky in case of rising inflation and economic shocks.

5. Consider a Fixed-Rate Mortgage Loan

There are currently variable-rate mortgages offered at about or even less than 1 percent. Getting a variable-rate mortgage sounds tempting as it looks like borrowing for nothing but it comes with a hitch. The fact is that a significant increase in mortgage rates could translate in hundreds and even thousands of dollars in interest over the loan term.

In comparison, five-year fixed-rate mortgages are currently available at about two percent. Regardless of inflationary pressures and rate fluctuations, borrowers pay two percent over the course of the mortgage. Locking in a variable-rate loan is a good idea when inflation is rising.

Investing in stocks, alternative assets, and real estate is worth considering given that high inflation could last for years. According to chief economist with Bank of Montreal Douglas Porter, inflation rates could remain at 3 – 5 percent for a year or even two. The outlook for the U.S. is similar, with prices and inflation rising until 2023. In fact, inflation south of the border is higher than in Canada, reaching 5.4 percent in June. Canada, however, is behind the U.S. on the path to economic recovery which is a red flag when it comes to recessionary pressures. Investing in physical and financial assets now can help mitigate the effect of expected rising inflation. With a variety of inflation-proof stocks such as energy and utilities and exchange traded funds, there are plenty of options to hedge against inflation.