Pennine Positive Portfolio becomes First Managed Fund Portfolio Service to Measure Impact

'Impact' is becoming a much used (and abused) term in the field of investing for positive outcomes. The clearest example of this is the BSF Impact World Equity Fund that lists mining, oil and tobacco companies among its many holdings. Everything has an impact but surely this one isn't positive! 

Other funds and managed portfolio services claim to invest positively, but how true is this in reality?  With the notable exceptions of Wheb, Threadneedle and Impax, listed funds have a woeful record of systematic reporting on their social and environmental impacts, tending to cite examples of holdings with a positive impact. This can be highly misleading, as the overall impact can be rather less compelling.  The financial industry is very good at reporting on geographic diversification, asset allocation and financial factors, so if funds are serious about positive impact, why don't they apply a similarly analytical approach to impact?

It gets a bit more complicated for managed portfolios of funds, because it requires analysis of each underlying fund.  3D Investing has undertaken what we believe is the first systematic analysis of impact of a portfolio of funds, in order to demonstrate the extent of any positive impact. We've done this by classifying each underlying holding in every fund held within the portfolio. This has allowed us to determine what percentage of the portfolio is held in positive impact areas including renewable energy, healthcare, low carbon transport and social infrastructure.

The Positive Pennine Portfolio 4 invests almost half in positive solutions

This demonstrates the difference to a conventional portfolio.  The Positive Pennine Portfolio is shown to invest 46% in solutions to social and environmental challenges whilst the FTSE100 invests 14% and also holds 27% of the portfolio in unsustainable companies, whilst the Positive Pennine Portfolio holds none.

The FTSE100 invests just 14% in positive solutions and 27% in unsustainable companies

The report seeks to present a balanced picture that doesn't just focus on the positive impacts but highlights any potential negative issues.

This makes for transparent reporting that properly demonstrates the true social and environmental impacts of a portfolio. We are delighted to be able to partner with Pennine Wealth Management in producing impact reports and hope to develop this further in the future.  The full report can be downloaded from Pennine's web site.

3D Funds Benefit from Brexit

So Brexit has happened but how has this affected the funds in the 3D Portfolio universe that seek to maximise social impact whilst minimising ethical compromise?  After an initial slump, global stockmarkets have shrugged off Brexit, rising across the board, but smaller UK companies have fared less well, with the big gainers being international exporters based in the UK who have benefitted from the fall in Sterling.  These macro factors have been positive for the 3D portfolio funds, especially the global funds which have risen slightly more than the average global equity fund since Brexit, a rise of more than 8%.




The UK picture is more mixed but two of the three selected 3D funds have more or less matched the UK Equity Sector which initially fell but has now recovered to just above its level before Brexit. The Alliance Trust Ethical Fund has performed less well, having fallen due its lack of exposure to pharmaceuticals and focus on smaller companies.  This is also true for other UK ethical funds which have suffered a significant fall by virtue of their focus on small and medium sized companies.
Moving to UK corporate bond funds, these have risen slightly in line with the sector, with rising demand for low risk assets.

Property has been one of the big casualties of Brexit with concern over a withdrawal of international investors. For example, REIT British Land is down more than a quarter 23 June, and general property funds have been closed as investors clamour for the exit.   Against this background our chosen specialist property funds have held up very well as these are far less influenced by international investment and are underpinned by long-term government backed rental streams.  Performance has been flat which looks very good against falls of 25% or more.



The social and environmental infrastructure funds have also held up rather well, with performance having been more or less flat or slightly down.

Clearly, in the long term the impact may be more profound, but the good news is that in the immediate aftermath, 3D Portfolios have been beneficiaries of Brexit. For more information on 3D Investing and Portfolios download the latest 3D Investing Presentation

Investing in clean energy - the low risk way

Clean energy has been one of the darlings of the sustainable investment world, at least in terms of investor demand.  Its something that every socially motivated investor wants to have in their portfolio, but until relatively recently, it has proven an almost unmitigated disaster area for investors.

Even now, most clean energy funds are languishing below the level they were 5 years ago, most significantly down in value.  Those that have limited the losses have only done so by diversifying into natural gas and stocks not directly related to clean energy.  And individual shares in the sector have been even more volatile. Vestas Wind, one of the leading wind turbine manufacturers is typical:

It may be that clean energy investment will prove to be highly profitable over the decades ahead, but the last decade has not been encouraging and this sort of volatility does not sit well in most people's portfolios.  So are there any alternatives and if so, are they worthy of consideration? I believe there are, and I'd like to highlight two ways of investing in renewable energy without being exposed to the volatility of clean energy equities.

The first is via environmental infrastructure funds.  These are a relatively recent phenomenon in the UK, and consist of large portfolios of renewable energy assets, often already operational and with long-term, relatively secure contracts for the energy they produce.  This removes much of the risk of planning and development, albeit with lower potential returns.  Typically, these funds are structured as investment trusts with a target initial yield of around 6% that is expected to grow in line with inflation.  Borrowings are secured for periods similar to the expected lifetime of energy generation, and income is underpinned by long term agreements, often in association with Government incentives.  All of this makes infrastructure funds a less risky way of investing in clean energy, albeit without the potential upside offered by renewable energy equities.  That said, an inflation linked dividend of 6% isn't to be sneezed at, especially when there is the potential for modest capital growth on top of that.  I suspect that many, if not most investors, would rather accept a lower overall return than take on a high level of volatility.

Most of the funds trade at a modest discount to their net asset value, and are either wholly focused on one form of clean energy (wind or solar), or a combination.  The table below summarises those available in the UK.  All of these funds are now paying dividends of 5.5% or more, supported by predictable revenue streams from operational assets.

There are also a number of funds that invest in environmental assets, of which a large proportion is invested in renewable energy.


The other way of investing in clean energy that I'd like to highlight is community share issues.  These are promoted as social investments as indeed they are, but they also offer long term income streams that might be considered to be less volatile than investing directly in listed companies.  There have been a proliferation of such investments over the past few years, boosted by Government tax incentives.  These took some of the risk our of investment by providing generous tax relief up front and with the maturation of the industry, the Government now considers that this is no longer appropriate.  Although disappointing, the withdrawal of tax relief is testament to the predictable nature of the income streams and the lowered risk of this type of investment.   The number of new solar investments has diminished sharply but there are still opportunities for both solar and wind investments in community based projects.  There are two very good community investment sites that facilitate investment in these type of projects.

The first is Ethex, a partner of 3D Investing.  Ethex makes positive investing easy to understand and do, providing a direct and personal way for individuals to invest in businesses they believe in.  It does this by providing in depth social and financial profiles that enable comparison of the investments.  Investment can then be made online in a simple and straightforward way.  Current offers include:

 

A 3 year bond paying 6% interest to finance new solar energy projects in the Bristol area.
 

A 2 year bond paying 5.5% interest to purchase the assets of a solar Community Interest Company.

 Shares in a Community Benefit Society with a forecast return of 6-8%, derived from investing in two community owned wind turbines.




The second portal for community energy investment is Abundance.  Abundance is wholly focused on community energy investment and offers peer-to-peer investments in long term debentures.  Most notably, Abundance has pioneered a pretty unique financing model, whereby the majority of investments offer the repayment of capital and interest every six months throughout the term of the investment.  So far, £1,241,437 has been paid back to investors by way of capital repayments and interest on £14,771,983 capital raised, offering proof of the business model.

Furthermore, it provides a secondary market in investments with £178,511 having been traded already.  This is very encouraging as these types of investment having historically proven to be very illiquid with poorly functioning secondary markets. 

Abundance has also enabled investment through a pension.  This is to be lauded as these investments generate long term income flows that match the required profile of an investor seeking income in retirement, or for whom the long term predictability of returns is highly desirable.  The usual financial caveats apply, but this is a very significant development.  Well done, Abundance.

How do you measure the social impact of an equity portfolio?

Impact investing, or investing for social impact, is one of the most interesting developments in the investment marketplace over the last few years.  This generally refers to illiquid securities that aren't traded on a recognised exchange and isn't the subject of this post, but one aspect of impact investing is very pertinent for listed investment portfolios - the measurement of social impact.  As impact investments are chiefly concerned with social impact, a lot of work has been done on demonstrating and measuring social impact.  In particular, the Global Impact and Investing Network launched the Impact Reporting and Investment Standards, a set of metrics to measure an organisation's social, environmental and financial impacts.

" We've not been very good at analysing social impact as an industry and could do a lot better"

Notwithstanding the difficulties of this for a highly diversified listed portfolio, I think we've not been very good at analysing social impact as an industry and could do a lot better.  Best practice currently consists of describing what a few selected companies do and the social merit of that.  Valuable as this is, it hardly paints an accurate picture and is woefully incomplete.  Detailing the social and environmental impact of one company is one thing, doing it for 100 or more companies is quite another.  Creating a mountain of data would not only be extremely time consuming but ultimately, might not be very useful.

Too much data would only confuse investors

My initial solution is to classify each holding according to its ethical function.  This enables investors to understand what role each investment plays in terms of social impact, and the make up of collective funds in terms of ethical characteristics.  Its a somewhat crude mechanism but I think it gives a fair picture overall.  There's an element of subjectivity in classifying what constitutes best practice or what is a social solution, but nevertheless, it does bring some objectivity and transparency.  In practice, I've gone through every single holding of over 100 socially responsible investment funds and categorised them according to the following methodology:

Little Ethical Merit
Core activity confers no clear social or environmental benefits.  This is self explanatory - stocks which might meet negative avoidance criteria, but which seem to offer little in contributing to a better world.

Solutions Based
Core products and services are of direct social or environmental benefit.  These include clean energy, resource efficiency, clean air and water, healthcare, education, public transport, safety, sustainable food and agriculture, social housing and inclusive finance. 

Best of Sector
Social and/or environmental practices are amongst the best in its sector.  Necessarily, there is some subjectivity as to what constitutes best practice in a sector, but both secondary and primary research is used to assess relative performance.

Game Changer
Game Changers are companies whose shares are easily trade-able and that are key players in moving to a more sustainable world.  They may have elements which are ethically controversial but they constitute major companies with a large capitalisation that have a clear sustainability vision and can demonstrate that they are implementing this.

Having categorised each holding, the ethical distribution can be made clear, following the same sort of analysis and discipline that typifies financial analysis.

 Ethical classification of holdings enables a simple for of social impact reporting

This makes comparison of the content of ethical funds that much more objective and based on evidence rather than ad hoc examples and ethical criteria.  It also gives a much better overall flavour of the fund.  I'll look to develop this over time, but I've found it to be a very useful tool for both analysing funds and for reporting to investors.

Investing with Integrity

In my last post I alluded to my concerns about the socially responsible investment (SRI) market.  I've always believed in putting my money where my mouth is, so I've experimented in developing my own portfolio over a period of several years and without going through the highs and lows of this, I've settled on an approach that I think has wider application.  I've called this approach '3D Investing' and it aims to maintain the ethical integrity of an investment portfolio by minimising ethical compromise, maximising social impact and meeting financial expectations.  My belief (based on 20 years experience of advising socially motivated investors) is that many investors, and especially those that have inherited large sums or who have been successful entrepreneurs, really do want to do more with their money than just make some more, albeit in a more 'ethical' manner.  They often want to be involved with their investments, seeing the difference they can make beyond financial return, and if they can see the social impact, may be prepared to take on a higher level of risk.

 "Many investors, and especially those that have inherited large sums or who have been successful entrepreneurs, really do want to do more with their money than just make some more"

I share these beliefs which are all based on maintaining a high degree of ethical integrity.  All fine words, but what does this mean and how can anyone else know whether it might resonate with them?  I'm therefore setting out the principles that underpin the 3D Investing approach.  Some of these might seem obvious, but the simple fact is that these are rarely followed in entirety and I don't know of any existing portfolio management service that embraces this philosophy.  So, I think it worth  documenting what I believe to be the core foundations of investing with integrity for socially motivated investors:


Inspiring investments
3D investments need to inspire the investor.  It’s no good just replicating an index.  3D investments need to be compelling.

Investing in the welfare of people can be really inspiring

Be transparent 
Transparency is at the heart of 3D investing.  If compromises have to be made (and they usually do), then you need to be confident that all of the pros and cons have been considered, and to be able to see the evidence.


Social impact is a core purpose  
It’s not enough to simply avoid the 'bads' (negative screening), choose the 'least worsts' (best of class) or to put a small amount of the portfolio in positively screened stocks (thematic investment).  Within the given financial parameters, the goal is to maximise social return wherever possible.
 

3D Investing is not philanthropy but rather, an investment approach

Financial returns should reflect the level of risk being taken   
It is not a philanthropic exercise, but rather a way of generating long-term financial returns commensurate with the investor’s attitude to risk. 


Minimise ethical compromise 
Some ethical compromise is inevitable but this should be readily defensible and reduced wherever possible. 


Take good risks 
Taking risk is part and parcel of 3D investing, but risks need to be quantifiable, known and reduced by utilising a wide variety of assets and by appropriate use of collective vehicles.   

Risks need to be quantifiable, known and reduced

Investments are not short-term trades
3D investing is all about investing in financially sustainable investments in the long-term.  This means low levels of turnover, which also means lower transaction charges. 

This is very different to most socially responsible investment portfolios and I'll explain why in my next post.

What's different about 3D Investing?

I previously outlined the philosophy behind the investment approach that I've dubbed '3D Investing', and in a continuation of an exploration of the thinking behind this approach, I'd like to explain why I think its distinctive and why I think its worth developing.

The ubiquitous wind turbine image can mislead

Its my experience that ethical or socially responsible investment portfolios often sound great in theory, and are promoted with pictures of wind turbines and the assurance that someone is looking after your money so you can sleep easily at night, but the reality is sometimes disappointing.   I believe that 3D investing is very different to this for a number of reasons.

 

Impact Measurement

The proportion of ethical funds investing in social or environmental solutions is often low, so your money isn’t actually doing that much good. 3D investing requires measurement of how much of each fund is invested in companies providing social solutions, and what ethical impact each stock has. It is then possible to identify those funds with a relatively high social impact, enabling investors to make a difference with their money. 

Highlighting Concerns

Typically, ethical funds profile companies with positive attributes but say little about more controversial holdings.  3D investing actively seeks to identify any potential areas of concern so that investors are aware of any social compromises and can make informed judgements as to social suitability.

 "3D Investing identifies areas of concern so that investors are aware of any ethical compromises, whilst also assessing how well a fund is addressing the inevitable ethical conundrums"

Maximising Financial Returns is not the Goal
Ethical investment is often reduced to maximising investment returns from a pre-described universe of ethically screened stocks or funds. Despite having an ethical badge, this does little to make a social impact. 3D investing does not seek to chase financial returns at the cost of watering down the social impact, nor is it a philanthropic gesture. Rather, it seeks to deliver on financial expectations by investing in a broad portfolio of well managed funds, all of which have a social purpose.


Investment not Trading
The average holding period of equities is measured in months rather than years. This makes ‘investing’ more like a trade than a true investment. There is no social value to this. 3D investing therefore holds investments on a long-term basis and does not seek to change them unless there is a fundamental change in outlook or the needs of the investor.

"Much 'investment' is trading with little social benefit" 

Wider Choice of Assets
Portfolio managers virtually all claim to spread risk by appropriate asset diversification, but this often comes down to a simple split between bonds and equities, with little or no allocation to alternatives. 3D investing offers a much wider choice of assets including microfinance, social property and infrastructure. As part of a diversified portfolio, these contribute to reducing overall risk.


Inspiring Investments
Investment is commonly reduced to facts and figures. Indeed some investment analysis discusses numbers without even stating what the company does! 3D investing seeks to inspire investors, to get investors excited about their money and what it can achieve.  Existing ethical investment providers try to do this too, but in all too many cases its a piecemeal approach whereby only a select few stocks are picked out, conveniently failing to justify the rest.

For me, inspiring investors across the spectrum of different types of investment and backing this up with clear evidence, is the essence of what I'm talking about.  Can I, with hand on heart, know that each and every one of my investments has a social value, and can I say what that is?  I hope I can demonstrate that this is indeed the case.

What's wrong with socially responsible investment?

Welcome to 'Make Money Work'.  I've been involved in ethical investment (yes I still like to call it that, despite the somewhat Presbyterian overtones) for over 24 years, firstly as an adviser and latterly as a researcher and developer of portfolio management services.  I'm a passionate believer in the power of money to do 'good' and in socially responsible investment (SRI) as a tool to help make the world a better place. 

Over the last 24 years I've seen the blossoming of what was a very small sector of the market to something far more significant and there's no doubting the good things it has achieved - raising corporate standards, financing new environmental technologies and providing a choice for socially motivated investors - but I have serious concerns about the socially responsible investment industry as a whole.  Here's why:



Lack of Transparency
Transparency is at the very heart of ethical investment.  Typically, ethical funds only list their top ten holdings as a matter of course and simple naming of companies won't mean very much to the average investor.  Furthermore, funds tend to profile companies with positive attributes but say little about more controversial holdings.  This isn't good enough.  Socially motivated investors would benefit from an ethical rationale for each and every holding, not just a select few.  Claims of the need for commercial confidentiality just don't stack up - a select few funds do this, so why not the rest?  And where potential areas of concern exist, investors need to be made aware of them so that they can make informed judgements as to social suitability.

" Why can't all companies tell us something about each and every company in which they are invested?"

Lack of Impact
Ethical or socially responsible investment is often reduced to maximising investment returns from a prescribed universe of ethically screened stocks or funds.  Despite having an ethical badge, this usually does little to make a social impact, since the proportion of the fund held in companies that make a clear social impact is usually low.  The stated positive criteria in non-thematic funds are little more than aspirational ideals, but having positive criteria makes it look as though the fund is actively invested in a positive manner when, in reality, only a very small percentage is invested in that way.  Stating the actual percentages invested in social and environmental solutions and describing each and every holding would go a long way to making the social impact clear and to highlighting those funds that actually make a social impact.  

"The average ethical fund invests less than 25% of the fund in companies whose core products or services are of direct social or environmental benefit"

Short-termism 

Trading adds little social value

The average holding period of equities is measured in months rather than years.  This makes ‘investing’ more like a trade than a true investment.  There is no social value to this.   Clearly, there is a need to change investments if the fundamental view on a stock has changed, but portfolios with high turnovers are indicative of trading which is purely dictated by financial considerations.  Many ethical portfolios seem little different from their conventional counterparts in this respect and this sits uneasily with the concept of investing to make a social difference.


Ethical Compromise
Despite having clearly defined ethical criteria, many, if not most ethical funds, seem to make major compromises that, if investors were aware of them, would very likely cause concern.  This demonstrates the problem of comparing funds based on criteria rather than content, which allows stocks that fit the criteria to be included even though they raise significant ethical issues.  Furthermore, sustainability funds justify selection based on their consideration of a company's sustainability profile.  Some of their conclusions are surprising to say the least.  How does Monsanto justify inclusion in a sustainable portfolio when it has run roughshod over farmers, citizens and countries, to the extent that online campaigning group is presenting the company with a prize for being 'the most evil company in the world'.  

How can 'the most evil company in the world' be a sustainable investment?

 Or how does Amazon get to be in a leading ethical fund when aggressive tax avoidance is a key part of its business model, and it stands accused of very poor employment practice?  I believe that investments like these undermine ethical investment and have no place in it.  If investors are to trust their investment manager, they need to be confident in the process and this means absolute transparency and a clear determination to minimise the ethical compromises being made.

After 24 years of researching and advising on ethical investments I have come to the conclusion that the existing portfolio management services are largely failing socially motivated investors who want to make a social difference with their money.  As a result I am attempting to help advisors and managers to develop and run services that better meet the aspirations and needs of these investors.  I'm calling it 3D Investing and I'll talk about it in my next blog entry.