Cut your portfolio’s risk – and feel good as well

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Canadian investors looking to reduce downside risk in their portfolio might want to shift their investment dollars into ethical funds that focus on responsible investing, a new study suggests.

Responsible investing (RI), also known as socially responsible investing, incorporates environmental, social and corporate governance criteria into the selection and management of investments.

For some investors, RI funds have been regarded as investments that could limit portfolio diversification, reduce returns and increase overall risk.

However, a new study commissioned by OceanRock Investments Inc. suggests that responsible investing provides a number of potential advantages, including strong financial returns, reduced risk and more downside protection than traditional mutual fund investments.

The study, Canadian RI Mutual Funds Risk/Return Characteristics, examines the relationship between risk and return in Canadian RI mutual funds to determine whether RI funds are able to provide solid financial returns for investors while simultaneously reducing risk in their portfolios.

"In the past, many of the RI studies only looked at financial performance. However, we know environmental, social and governance factors seem to lower risk in an investor's portfolio," says Dr. Tessa Hebb, director of the Carleton Centre for Community Innovation at Carleton University, who conducted the study on behalf of OceanRock.

"We found that RI funds are able to protect investors from downside risk in their equity portfolios.

"The significant correlation between RI and improved downside protections are new and notable, and come at a time when many investors approaching retirement are worried about protecting their assets and want to sleep better at night."

The study looked at all of the approximately 100 RI funds in the Canadian marketplace and found that many are outperforming peer benchmarks.

The study looked at RI funds' risk and return characteristics against the average risk and returns for Canadian mutual funds across eight common fund classes in Canada including equity, fixed income and balanced mutual funds.

Observations were compiled using one-year, three-year, five-year and 10-year fund data to the end of March 31, 2015.

Using those four different time frames, Canadian-based RI equity funds outperformed their non-RI peers 63 per cent of the time on average, while Canadian-based RI fixed income and balanced mutual funds outperformed their non-RI peers 67 per cent of the time.

"In the past, investors and advisers may have seen RI funds as not being financially competitive, and now we are able to show that is not the case," says Gary Hawton, president of OceanRock.

"We have suspected that responsible investing led to reduced risk and greater downside protection for investors, but that notion has not been qualified until now."

Responsible investing is starting to gain traction with investors.

According to the Responsible Investment Association of Canada, assets under management increased to more than $1-trillion by the end of 2013, a 68 per cent increase from two years earlier.

The majority of that growth stems from institutional investors.

However, retail RI mutual funds and venture capital funds in Canada have grown from $13.48-billion to $17.5-billion over the same two-year period.

The growth in retail RI funds could stem from an increase in regulatory requirements for companies to be more transparent on their annual reports around socially responsible investing, says Patti Dolan, a financial adviser with Raymond James Ltd. in Calgary, who has 50 per cent of her clients in responsible investments.

"The reporting from companies has become a lot more sophisticated and the ESG [environmental, social and corporate governance] reporting has really developed over the years from when I first become involved with responsible investing in 1995," says Ms. Dolan, who also is a director with Canada's Responsible Investment Association.

"Investors are now looking at more ways to analyze a company.

"In the last two years, I have seen my business grow by 40 per cent, and I would attribute most of that growth to responsible investing."