The Wall Street Journal reported that major U.S. funds promoting companies sensitive to environmental, social and governance (ESG) issues are likely to hold oil and gas stocks in what seems like a direct affront to the whole initiative.
“Funds with a focus on socially responsible investing are enjoying a record year of inflows. But many such portfolios aren’t as clean as investors might expect. Eight of the 10 biggest U.S. sustainable funds are invested in oil-and-gas companies, which are regularly slammed by environmental activists.”
There are structural excuses for why this is happening – in one case the fund mandate chooses the most ESG-responsible firms within each sector, including energy – but the underlying reason is performance.
The consistent underperformance of active fund managers highlights the difficulty stockpickers face when competing with the benchmark, and that’s before limiting the available investment options with non-financial criteria like ESG do.
A rigorous academic study by former University of Denver economics professor Tommi Johnsen found that “Restricting the universe of stocks by screening out ESG companies shifts the [portfolio efficient frontier] downward.” In simpler terms, this means that expected risk-adjusted returns are lower for ESG investors. Professor Johnsen described this as “not a surprising result.”
Professor Johnsen does describe ways in which ESG portfolios can be optimized for risk-adjusted returns – this involves shorting non-ESG compliant stocks and using the proceeds to buy stocks that qualify – but these strategies are attractive to a limited percentage of investors.
Markets can get weird in cases of shunned sectors. Tobacco stocks are arguably the most hated market segment ever, but as The Motley Fool site noted last year, Altria Group was the top-performing U.S. stock from 1968 to 2018 with a 20 per cent per year return that dwarfed the nearest rival.
None of this means that investors shouldn’t invest in ESG funds or that they shouldn’t go through the holdings list carefully before they do. The extent to which politics is reflected in investment portfolios is a personal decision and there’s no right answers or priorities.
Importantly, the conclusions of all of the studies on ESG investing may not even apply in a future dominated by renewable power and electric vehicles. If, hypothetically, a stock like Denmark-based Vestas Wind Systems AS becomes the next Amazon.com, then all of the financial research will need to be re-written.
Investors should, however, know what they are likely up against before they combine political advocacy and investing, and be sure that what they add to their portfolios truly reflects their intentions.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
GDI Integrated Facility Services Inc. This is an industrial stock seeing positive price momentum after the company reported better-than-expected third-quarter financial results. This small-cap stock has delivered a large year-to-date gain - rising over 73 per cent. Despite this major move, analysts remain bullish, with five analysts increasing their target prices this month. Jennifer Dowty profiles the stock.
AutoCanada Inc. The company hasn’t generated a profit for six consecutive quarters but investors are sensing that the Edmonton-based car dealership’s worst days are behind it: The shares have surged more than 40 per cent over the past month. Is it worth jumping onto this rally? David Berman shares his thoughts.
Stryker Corp. Concerned about the end of the market cycle and not willing to trade short term, Scott Barlow has been waiting for buying opportunities and not doing much in his personal portfolio. Earlier this month, however, a stock in one of his favoured sectors sold off and became too attractive to skip. He provides four reasons why he’s taking a bet on Stryker.
Nostalgic for bonds with 5% yields? These blue chip dividend stocks may help you get over it
Rob Carrick remembers stuffing a five-year GIC with a 5-per-cent yield into his sons’ registered education savings plan back in the mid-2000s. Today, half that yield would be typical if you’re GIC shopping. But if you’re open to 5-per-cent yields from blue chip stocks rather than GICs or bonds, you do have a few possibilities. Rob outlines who they are.
Presenting the ‘Champagne portfolio’ for Canadians: Stock-like performance with bond-like downside protection
Investors pop open the Champagne when stocks hit new highs. But after quaffing down a boatload of bubbly in recent months, the newly rich might wonder how long the good times will last and whether now is a good time to put new money to work. Norman Rothery created the Champagne portfolio to explore the situation. It invests in the Canadian stock market when it hits a new all-time high, but hides out in Canadian bonds the rest of the time. The result was stock-like performance with a bond-like downside profile.
Others (for subscribers)
Wednesday’s Insider Report: Insiders scoop up shares of these 3 stocks on price weakness
Tuesday’s Insider Report: Billionaire mining mogul tops up his investment in this stock with a $700,000 purchase
Others (for everyone)
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Ask Globe Investor
Question: I have topped up my RRSP, TFSA, and non-RRSP money. I took retirement about two years ago at age 55. For the best tax implication, which order should I take the money? RRSP first? Last? The order?
Answer: Normally, my advice would be to leave money tax-sheltered for as long as possible, which would imply using the non-registered funds first.
However, in this case you need to do some creative planning. You are not old enough to draw old age security yet but when you reach age 65 any money withdrawn from your RRSP (or subsequent RRIF) will count as income and could push you into clawback territory. This year that threshold is $77,580. Inflation will move it higher by the time you are eligible. The surtax is 15 per cent on every dollar of income above the threshold, over the above your marginal rate.
If you believe you will be over that income level at age 65, then I suggest you draw down your RRSP first to avoid the clawback. If your income is unlikely to be that high, use your non-registered funds first, since they attract tax for any dividends, interest, or capital gains that you earn. Keep your TFSA until you absolutely need it. Any money withdrawn from it will not affect your old age security.
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What’s up in the days ahead
Home Capital Group shares surged Wednesday after better-than-expected earnings. Will the company soon restore its dividend? David Berman takes a look.
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Compiled by Globe Investor Staff