Australians and New Zealanders increasingly are interested in how they can make their investment decisions accord with their views about climate change and environmental sustainability. A good first step is to define your goals.
For example, our household is deciding about installing solar power at home. We’re motivated primarily by reducing our use of fossil fuel-derived energy sources. But we also want the financials to add up so that we ultimately cut our energy bills.
Our local council is seeking feedback from residents on a proposed high-rise development. We understand the need for medium-density housing to reduce urban sprawl, but we’re also concerned about the resulting rise in noise and traffic.
As consumers and as citizens, we’re constantly faced with such trade-offs in making decisions around sustainability. In investment, it’s no different. We want to do the right thing by the planet, but we also want to meet our long-term wealth goals.
Finding the balance
The good news is that it is now possible to build an effective investment solution that maximises your chances of getting to where you want to be financially, while reducing the carbon footprint of your portfolio and focusing on a host of other environmental and social variables.
The key to this approach to investment is to focus first on sticking to core principles, such as building your portfolio around the long-term drivers of higher expected return, diversifying broadly to manage risk and keeping your costs low.
Once those elements are in place, you can go about reducing your exposure to the companies with the highest level of greenhouse gas emissions “intensity”. This refers to a way of measuring emissions relative to the size of the company in terms of its revenue. Obviously, a bigger company will often generate more emissions than a smaller company so you have to account for that.
At the same time, you can overweight those companies that have lower greenhouse gas emissions intensity. But that’s not the end of it. What about all that coal and gas in the ground? We also want to account for the supply side of emissions, companies with large amounts of fossil fuel reserves which can be viewed as potential emissions to be generated once these reserves are harvested and consumed.
Alongside emissions and potential emissions, you can take account of other environmental issues like land use, biodiversity, toxic spills, operational waste and water management. And you can consider social issues like child labour, alcohol, tobacco, gambling and firearms.
It’s important to understand that no single investment solution will ever tick every box for every person. But you can go a long way to meeting your goals if you supplement your choices as an investor with your choices as a consumer and as a citizen.
For instance, while there may not be an option in your investment portfolio to invest in recycled plastic and paper, you could decide as a consumer to insulate your home with such products. No wind or solar farms in your portfolio? Why not switch to an electricity provider that relies on renewable energy?
Of course, decisions around sustainability can often be made more complicated for an individual by the sheer volume of jargon involved. What does ESG mean, for instance? Socially responsible investing? Impact investing?
This is where a professional financial advisor can be valuable, helping you to navigate the technical jargon and all these choices to arrive at a diversified solution that meets both your personal values and your financial goals.
Ultimately, the job of your advisor is to help you achieve the dual goal of efficiently taking into account sustainability and social considerations while building robust investment solutions aimed at growing savings for future consumption.
The advisor will focus first on choosing an investment methodology that emphasises the sources of higher expected returns while minimising turnover and trading costs. Once this framework is in place, we can get to work on the other part.
Evaluating the companies
That second phase starts with evaluating companies on a broad array of sustainability measures across all industries. That means looking at companies across the whole portfolio and within individual sectors, with a view to both incorporating sustainability preferences while maintaining as much of the characteristics of the original strategy as possible.
Specifically, the worst carbon polluters across all industries are kicked out of the portfolio altogether.
Within each industry, the least sustainable companies are excluded, while the rest are overweighted or underweighted based on how well they rank among their industry peers. By using this scoring system, rather than an in-or-out screening process, we can preserve diversification while encouraging good behaviour.
Taking this combined industry and portfolio approach allows for a dramatic reduction in carbon emissions–an important goal for investors–while maintaining diversification and the focus on the drivers of expected returns.
Just as a weight loss program makes no sense without a set of scales, if you want to invest sustainability you need to be able measure the impact you’re having! In a global sustainability portfolio, for instance, emissions intensity can be cut by 80% or more and up to 100% for potential emissions from reserves.
With social screens, we can take more of a black-and-white approach. So companies that draw a significant proportion of their revenues from tobacco, gambling, or one of the other proscribed activities can be excluded altogether.
Importantly, this process of screening and exclusions can be applied to fixed interest component of a portfolio as well as to the equity component. The principles and the approach are broadly the same.
Taking a global approach to sustainability
A further consideration for investors in Australia and New Zealand is to be mindful of the impact of sustainability and social screens in markets that are already, by global standards, small and highly concentrated.
For instance, excluding large carbon-intensive companies like BHP Billiton or AGL Energy from an Australian share portfolio over the 28 years from 1990 would have led to a portfolio that looked significantly different to the market at times.
This ‘tracking error’ can be ameliorated by taking a global approach to sustainability. In other words, the less your bias to domestic stocks, the less likely you are of straying a long way from the index as large local companies become a smaller part of your total portfolio. And given the higher emissions intensity of Australia, shifting the weight to global equities also leads to a lower carbon footprint for your portfolio. Win-win in other words!
The key point to take away is that investing well and sticking to your values around sustainability need not be incompatible concepts. But as always you have to take a systematic approach, one that observes the principles of diversification and targets the sources of higher expected return.
As we’ve seen, this process is made a lot easier by having an advisor who understands your goals, risk appetites and values.
Whoever said it’s not easy being green?
By Jim Parker, Regional Director of Communications and Vice President, Dimensional Fund Advisors (DFA)
First published by DFA 5 February 2021
Disclaimer: Information as at 2 December 2022. This article is general information and does not consider your financial situation or goals and does not constitute personalised advice. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included as part of this article.
This material is issued by DFA Australia Limited (incorporated in Australia, AFS License No. 238093, ABN 46 065 937 671). Investors should also consider the Product Disclosure Statement (PDS) and for the Dimensional Wholesale Trusts the target market determination (TMD) that has been made for each financial product or financial advice product either issued or distributed by DFA Australia Limited prior to acquiring or continuing to hold any investment. Go to to access a copy of the PDS or the relevant TMD. Any opinions expressed in this material reflect our judgement at the date of publication and are subject to change.