Three-quarters of Canadians say socially responsible investing is the way of the future and almost half say environmental issues matter most to them when it comes to investing, according to a 2020 Ipsos survey. That’s consistent with our experience, where increasing numbers of our clients are asking for a socially responsible portfolio that reflects their concerns about climate change. It’s important to recognize, however, that a portfolio created using environmental, social and governance criteria (ESG) is not the same as a portfolio that’s divested of fossil fuels.
Environmental, social and governance (ESG) factors aren’t typically used to eliminate a type of investment from a portfolio. Instead, ESG criteria are used to compare issuers to determine which one is a better investment, relatively speaking. It is definitely possible to hold an oil company in an ESG portfolio. The oil company would just compare more favourably than its peers on environmental, social and governance criteria. It might have better environmental practices than other oil companies, for example. Or it might have more gender diversity on its board. Or a better safety record. Or it may also have alternative energy and technology projects on the go. All of these make it a better investment than another oil company—but it’s still an oil company.
Since there’s no regulator overseeing responsible investing, including the use of terms and monitoring adherence to third party standards, funds can make their own rules and decide how strict their portfolios will be. All they need to do is follow their own guidelines, which can be found in their prospectus documents.
This allows ESG investments to be labeled with a number of confusing terms such as “carbon neutral,” “climate aware,” “carbon constrained” and “low carbon.” The lack of consistency and transparency in labeling makes it difficult for investors to compare apples to apples when choosing a fund.
One low carbon fund, for example, might be heavily invested in energy and mining. Another might be invested in military companies or firearms. A third may invest in companies with coal reserves. InfluenceMap looked at one fund marketed as “fossil fuel reserves free” that was invested in thermal coal. When questioned about it, the fund managers argued “fossil fuels” referred only to oil and gas.
Do you consider coal a fossil fuel? Are you concerned with the refinement, transportation and distribution of fossil fuels, as well as their extraction? If so, it’s important to look closely at the holdings of any ESG fund. Often you’ll see the only difference from mainstream funds is a higher management fee. That was the experience of two university professors who set themselves the challenge of keeping their investments in Canada and investing in climate-friendly funds. When they compared XIU, the largest Canadian ETF, with XESG, a Canadian ESG fund, they found both funds invested close to 15% in the energy sector and their third-largest holding was oil and gas transportation company Enbridge.
The best approach to ensuring your portfolio is fossil fuel free—according to your definition, and not simply a fund prospectus—is to develop a close relationship with a portfolio manager. As your responsible investment steward, your portfolio manager will be very familiar with your values and will select your investments based on your very specific exclusion criteria, all the while ensuring your portfolio is constructed to deliver a reasonable risk and return.
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