Sustainable Index Investing Is A Joke


sustainable index

disaster! - Off-Highway, Athabasca Oil Sands © by jmegjmeg

How’s that for a title kids? That ought to get at least a few of you a little hot and bothered, huh? Sustainable index investing is a joke.

I love the environment so much that I want to just give a tree a great big hug sometimes. (See what I did there?) In fact, starting right now, I’m going to make sure all my decisions are based on what’s best for the environment. If I know someone who isn’t recycling, I’m going to punch them in the face. If I see a car with the engine idling, I will shut it off and throw the keys into the nearest snowbank. I will find a t-shirt made of hemp and wear it continuously until it smells like a bag of hockey equipment in February. (Canadian joke!) And, starting right this minute, I’m only going to invest in companies that have sustainable business practices.

Luckily for me and my laziness, there are all sorts of mutual funds already set up that exclusively invest in sustainable businesses via a sustainable index. One of the best performing ones is from RBC, it’s called the RBC Jantzi Canadian Equity Fund. It’s actually up 10.2% annually for the past 3 years, which makes it a pretty solid performer compared to some of the other eco-friendly funds out there. Rather than just blindly believing that it’s an environmentally friendly fund, let’s take a look at some holdings of the fund, just to make sure. Internet fairies, do your thing:

Top 10 Sustainable Index Holdings

Royal Bank of Canada
The Toronto-Dominion Bank
Newmont Mining Corporation
Bank of Nova Scotia
Suncor Energy Inc
Canadian Natural Resources
Potash Corporation of Saskatchewan
Canadian National Railway
Bank of Montreal
CIBC

Uhh… these are the best sustainable companies in Canada? Is oil sands producer Suncor really the best choice to go into a fund like this? Newmont Mining? Really? Where are the solar and wind power companies? What’s up with all the banks on there? What do they do to help the environment, besides recycling their bottles?

Just for the fun of it, let’s take a look at the 10 biggest companies in Canada, based on market cap:

Top 10 Companies

Royal Bank
TD Bank
Bank of Nova Scotia
Barrick Gold
Suncor Energy
Goldcorp
Canadian Natural Resourses
Bank of Montreal
Canadian National Railway
Potash Corp of Saskatchewan

But those are practically the same… This exercise continues to be fun for me. What’s the difference in management fees?

RBC Fund: 2.11%

XIU ETF: 0.17%

Okay, I’m picking on just one fund. Maybe there aren’t that many Canadian companies that are actively trying to better the environment. Let’s take a look at a fund from Bank of Montreal, called the Global Sustainable Opportunities Class. Maybe this fund has made some better investment choices. They have the whole world to pick from, not just Canada. Rather than making you sit through another top 10 holdings list, let’s just look at the top 3.

Top 3 Holdings

Nestle
Vodafone
BHP Billiton

Seriously, their top holding is Nestle. This is the same company that sells billions of bottles of water in North America alone, each one in a little plastic bottle that no one can argue is good for the environment. Their 3rd biggest holding is global mining conglomerate BHP Billiton. While BHP doesn’t have the reputation that Exxon Mobil or BP have, a mining company isn’t really the best choice for a mutual fund based on sustainability.  How does it get included in a sustainable index?!

If there’s a sustainable index fund that’s actually investing in green initiatives, I couldn’t find it.

Might I suggest an alternative to your sustainable investing ways? Maybe you shouldn’t bother.

A publicly traded corporation exists for one reason – to make shareholders money. After all, they are the owners of the thing. They elect a board of directors who attempt to make the company as profitable as possible. A corporation doesn’t exist to give people jobs, or to donate to charity or to do good things for the environment. Sure, a corporation may decide to do these things, but only after the shareholders have made money.

When a company issues shares to trade on the stock exchange, only one thing determines whether they’ll end up being bought – demand. If there isn’t enough demand for the shares, the issue flops and it never makes it to trading on the exchange. If there is demand it’s because investors think they can make money off the stock. As long as it’s legal, investors will snatch it up.

Once the shares hit the stock exchange, someone owns every single one of them. A sustainable thinking investor may boycott those shares, but it doesn’t do much good. Someone still owns those shares and they can find someone else to sell them to. All you’re accomplishing is feeling good about your choice to not support those evil companies. And yet, those evil companies just keep on doing business as usual.

Companies like Wal-Mart will implement environmentally friendly initiatives in one segment of their “sustainable” business, while running other parts of their business with little regard to the environment. Only a complete moron believes Wal-Mart cares about the environment. The folks from Bentonville care only for their bottom line, and if making certain changes that happen to help the environment better that bottom line, then they’re all for the change. Just about every other large company around the world operates in much the same way.

In theory, a company with little concern about the environment will make more money, since they’re not wasting any of their cash on any green stuff. Also, how is the average Joe investor supposed to really know how green friendly a company is?

Which is why you shouldn’t bother with sustainable index investing. Instead, do like the rest of the market does. Put your cash in the spot where you feel it’ll get the best return. Then, if you’re so inclined, spend your profits on whatever environmentally friendly hippie stuff you want. Investing should be about making money, not saving the world. The two just don’t mix.

What are your thoughts on sustainable index investing?

Sustainable PF: I have had this topic on my “to write” list for some time. I was pleasantly surprised Nelson decided to tackle it and even more surprised my views were much like his.  For the record, these sustainable index funds are modelled to include the “best of industry” so of the oil sand giants, at least one has to be more socially responsible than the others.  Ridiculous from my perspective. Instead of these “sustainable” index funds (of which, the iShares Jantzi Social Index Fund (XEN) has a MER of 0.50%)) we opt to invest in individual renewable energy companies, especially hydro power while we avoid oil etfs!

 

33 comments to Sustainable Index Investing Is A Joke

  • brad

    I agree with this, but change is a-coming. First, there is a new class of companies called B-corporations, whose performance is measured on environmental and social terms, not just financial. If a B-corporation turns a nice profit for its shareholders one year but fails to meet its environmental and social goals, its performance is judged a failure by its shareholders. There aren’t many B-corporations yet in Canada (about 25), but that will change.

    Second, and perhaps more important, it’s not clear whether buying equities on a stock exchange actually helps companies you want to support or hurts companies you want to boycott. When you buy shares in an index or other fund, you’re normally buying them from another investor who’s selling those shares. So your money isn’t going to the company, it’s going to that investor’s pocket. Yes, the fact that you’re buying the shares does at least help keep the company’s share price up, but it seems like a very indirect and dubious way of making your investments reflect your values.

    The new and exciting approach to all this is something called “impact investing,” in which you invest more directly in companies and organizations that are doing work that reflects your values, while earning a decent return. The opportunities for small-time retail investors to do this in Canada are currently limited, but that is changing as well. High net-worth investors have seen returns of 200% or more on some impact investments (and of course some of them have lost 100%, that’s the risk you take with any equity investment); most of us retail investors who want to get into impact investing are currentl limited to returns in the single digits, because most impact investment opportunties for small investors in Canada are focused on debt rather than equity.

    Do a Google search for “impact investing”+”Canada” and you’ll quickly find the main sources. I also highly recommend the book “Impact Investing: Transforming How We Make Money While Making a Difference,” by Antony Bugg-Levine and Jed Emerson. The MaRS Center in Toronto is doing a lot of work in this area on the Canadian front. This is an area to watch; I think we’ll start to see a lot of interesting opportunities open up in the next few years.

    • Fantastic information, as usual. Thanks Brad. I have started to look at impact investing but I still have lots to learn.

    • Nelson Smith

      Great comment Brad, and you’re right, impact investing can only grow. However, I think the vast majority of investors (and companies) will only consider sustainability as just an afterthought. When I analyze a potential investment, sustainability barely enters my mind.

      • brad

        Right, but it doesn’t have to be that way. The MaRS center is working on developing a separate exchange just for impact investments. If you were to buy and sell equities on that exchange, you’d only be dealing with companies focused on sustainability and/or social improvement.

        I think Occupy Wall Street has made a lot of people think hard about whether they want to keep investing in publicy traded companies or whether instead they can put their money to work now to improve the world while still earning decent returns. That notion is at the heart of impact investing: standard stock-market investing creates a huge opportunity cost, because your principal isn’t doing anything. In impact investing, your principal is being used directly to help change the world, plus you get returns on top of it. Wha’s not to like about that? The answer for now is that the monetary returns are smaller, but it depends on your priorities: if you’re willing to accept smaller financial returns for bigger social/environmental returns, it could be worth it.

  • Damn you Nelson, I am just finishing up an eBook on this mutual fund dressing up as an ETF phenomenon! Must be a pretty sweet gig to have as a money manager though eh? Walk into the boardroom, so… uh… we’ll switch the holdings percentages between #7 and #8 on this ETF, and then we’ll pocket millions of dollars selling this to people who don’t know the difference. Ok… coffee break.

  • The concept is very interesting, but I want profits and socially responsibble behavior. Is that sustainable?

    • brad

      The notion that investing is only about money and you should use philanthropy to support your social and environmental values is a hoary old farce; it is entirely possible to integrate them; see my comment above about impact investing. Many profitable companies also have strong environmental and social policies; the two are not mutually exclusive, and in fact many environmental initiatives (such as energy efficiency) improve a company’s bottom line. DuPont has saved more than $3 billion over the past 10 years by reducing its greenhouse gas emissions way below the targets set by the Kyoto Protocol, for example.

      Impact investing is about changing your definitions of “value” and “return on investment,” so you’re demanding a social/environmental return as well as a financial one. That’s a perfectly viable, logical, and sustainable model. Unfortunately for those of us in Canada there aren’t a lot of financially attractive opportuniies for impact investing yet, but they are coming.

      • Sustainability is a long term strategy to try to reverse not only the earth/environment/health but also to bring some balance back to the economic systems that need to change course.

        Lets face it – business and industry is a given as we get to the end of 2011. However, true long term growth can only occur if the resources, methodologies, paradigms and strategies that are used, can be sustained by the infinite world. Companies have to think long term and they will have to see they cannot continue to profit by continuing their current business practices.

        It can pay to be green/sustainable/ethical.

      • Nelson Smith

        Yeah, you can combine sustainability and investing. But, by doing so, you’re severely limiting your options. There might be only 2 or 3 companies out of 100 that actually have sustainable practices. Those odds are too high for me, a guy who already has trouble picking stocks.

        • brad

          Like you, Nelson, I decided long ago that standard index funds were the way to go, and that’s where 80% of my portfolio lies. I’ve never in my life purchased an individual stock; one of my goals in life is to spend as little time managing my money as possible, and I want to take a simple approach. So index funds have worked well for me so far.

          But now that I’ve learned about impact investing, I’m taking the radical (and most would say foolhardy) approach of transferring my entire investment portfolio out of the market and into a special line of GICs offered by my local credit union, which uses the principal to provide loans to social and environmental projects. It’s still a simple investment approach, I don’t have to do any research or sweat over whether I invested in the right company, and I have the satisfaction that my principal is being put to work right now to make my community a better place and to help improve the environment. The tradeoff is that I might have to live on cat food during my later years in retirement, but it’s a risk I’m willing to take. I believe in walking my talk, and I’ve always been a risk-taker, so this approach works for me. Once the field of impact investing develops enough to provide equity investment opportunities to small-time investors like me, I’ll add those to my portfolio to boost my chances of higher returns.

  • I think it’s a bit of a bummer that it’s so hard to invest sustainably and expect decent returns. I feel pretty guilty having money tied up in Exxon-Mobil simply because the funds I invest in include them as a top holding. I feel like this has to be something that’s due for change in the next few years, and I’ll be eagerly awaiting that day.

    • We struggle with this all the time Jeffrey. I like to think I know the basics about major industry in Canada and it is resource, energy (extraction and distribution), telecom and banking/financials heavy.

      1/2 of the best choices, when investing at home, are hard to justify investing in, from our perspective. Mining, pulp and paper – then oil (sands and drilling), natural gas, coal. But how do I ignore 50% of our major industries?

  • Great post Nelson! This is something I have struggled with for a long time now. It is really important to me to invest sustainably and I know that index funds are a great way to invest, but like you have shown this does not mix well. I know we are to invest to make money but it just really bothers me to invest in companies I know are contributing to global pollution. It really will keep me up at night. I am hopeful that I can somehow find a way to make the mix work.

  • Great post. Unfortunately if you’re into investing in socially responsible companies, funds are not the way the to go. You’re better off doing the research, finding companies that are trying to make a concerted effort to be responsible, and buying it’s stock.

    • That is our take JP. The funds don’t make sense, but the issues don’t just lie to resource based indices.

      Just because Coca Cola puts a nice budget to being sustainable, they also market it heavily, and, what they do allocate to appeasing the green/sustainable movement are largely PR and a drop in the bucket compared to the nastier side of their business that ignores what they do to make that yummy, cold can of Coke. But thanks for allocating money to “save” polar bears. Great, except their other business practices contribute to the fact the polar bear needs sea ice …

      /rant

  • Hunter - Financially Consumed

    Excellent article. The hypocrisy is difficult to swallow.

  • Good looking out at the actual holdings. I’m sure many people just invest and don’t think twice. I can’t believe that Suncor is a top holding!

  • There is certainly no reason for profitable companies not to have good environmental poliices, as the DuPont example shows. It is rather like good employment practice – treat your employees well and that will be repaid with loyalty. This of course works best in areas where high levels of education are necessary (Google etc) and I guess the same works in environmentally friendly companies. In other words I doubt that companies working in mining where all they need is brute strength and stamina are going to be too good but an energy-intensive scientific company may be.

    The problem as always is to find these and ensure they continue while many other companies don’t and money doesn’t really care where it is made.

    Interesting issues anyway.

    • Nelson Smith

      I think that most companies want to be sustainable for only one reason: increased profits.

      • brad

        It’s not entirely true. One of the big socially responsible investment ranking firms did a study some years back that demonstrated a high correlation between strong management at companies and environmental performance. Companies that are well run can afford the “luxury” of focusing on their environmental performance, since they’ve got all the other essentials under control. And sometimes companies want to be sustainable because it’s important to their leaders. They would be foolish to keep their sustainability goals a secret, so you can’t blame them for using it to their marketing advantage, but profit is not always the primary motivator. Companies like DuPont, Interface, Xanterra Parks and Resorts, etc. see sustainability as part of their mission, not just an opportunity to make another buck.

  • Good comments. I’m surprised that more ethical-SRI investors don’t just simply analyse their personal values and then with the help of a broker, find stocks that more closely mirror those values. And you can get reasonably good diversification with a portfolio of 10-15 stocks. Also, they’ll find their transaction costs a pittance compared to the MERs of funds and thus their long-term returns potentially higher. (Note: ethical ETFs usually have similar holdings to ethical funds, and have lower costs too.)

    I believe what stops investors from doing this is that they are afraid of their advisors–who often can sell them only funds, not stocks–and they don’t know where to begin.

    I’ve been following ethical investing/SRI for over forty and have a significant background in the investment industry.

    In 2003, I founded a site to educate investors about ethical investing. It’s now one of the foremost global sites on the subject. It’s also Canadian based. It’s at http://investingforthesoul.com/

    Best wishes, Ron Robins

  • I bought an indulgence with some shares of a geothermal energy company. It balances out the other oil and gas stocks.

  • I feel the same way when you research faith based index funds…you check out the holdings and it is almost laughable.

  • Great post!

    Nelson, I couldn’t tell you were writing it!! What happened to your jokes and your crass humor? ;)

    Yeah, I’m not a big fan of ‘sustainable investing’ really, I think it’s a marketing ploy to capture the recent “green” movement, but that’s just me and my cynicism.

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