INVEST IN THE FUTURE: SUSTAINABLE AND SOCIALLY RESPONSIBLE INVESTING

 

ENVESTNET PRACTICE MANAGEMENT SERIES

KEY POINTS

The wind is behind our backs. Americans
elected a president with a deep commitment to creating energy independence
and fighting climate change. His stimulus bill included $79 billion dedicated to energy independence aligned with job creation, and the 2010 budget contains similar incentives.

The evidence is clear that SRI financial performance is essentially on par with traditional investments, although perceptions lag. In fact, a strong case is made that companies with a sustainable
platform in their business decisions
are potentially more successful than those that are more short-term in their approach.

For many reasons, advisors have not yet caught the wave. SRI is an expertise waiting to be explored and developed – a clean, flexible way to strengthen their client base.

Sometimes the most exciting events in our lives are happening just below the surface.

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Did you recognize the potential for Apple Computer when Steve Jobs and Steve Wozniak came up with the personal computer in 1976? What were you doing the day Bill Gates secured a contract to create an operating system for IBM’s PC? These events shaped our lives beyond comprehension, and early investors who recognized the growth potential of Apple and Microsoft were richly rewarded.

What is happening today that parallels the rapid growth of those two technology companies? Technology continues to produce innovations but the stage is broader now.

Sustainable investing has the potential to drive the next wave of entrepreneurs and high growth companies. Demand for socially responsible companies, combatting climate change, and energy independence are among the movements that support that broader scope of sustainable investing. Covering a broad range of practices, sustainable investing is marked by a clear focus on long-term impact and renewability of resources.

Americans are changing their habits as the message to “go green” is now woven into the fabric of our everyday lives. And these new practices are expanding awareness of the many changes that are in store for us as sustainable living picks up momentum. It is time to make sure that your clients recognize the potential of sustainable investing – looking at new, positive companies and processes that will not only transform our lives for the better but that can also possibly improve performance in their portfolios.

While sustainability can be applied to any business practice, the most visible effort is going into the search for sustainable, clean energy. Consider these examples.

• Water Power: Rivers and Tides. In New York City, a company called Verdant Power has been working to harness clean, renewable energy from river and ocean currents. The company’s RITE Project is designed to harness the rapid currents of the East River, using underwater turbines. An advantage is that consumers of the energy – the tall buildings that line the river – are nearby. But – no one said it would be easy. The strong current initially damaged the turbine blades, which were replaced with aluminum.

Once the project is up and running, Verdant plans to install up to 300 turbines in the East River that could power more than 8,000 homes. The company’s RITE Project has generated about $2.5 million from the New York State Energy Research and Development Authority as well as the U.S. Department
of Energy.

• Water Power: Ocean Waves. On the other side of the country, Pacific Gas & Electric Co. is working to create power from ocean waves. With its WaveConnect pilot project, PG&E “could by next year deploy five commercial-scale wave systems, each putting one megawatt of ocean-generated power onto the electric grid.”1 While the prototype would generate less than one percent of a coal power plant, experts say that 17 percent of California’s electricity could be produced by wave energy.

• Natural Gas to Diesel Fuel. The world’s largest gas-to-liquids plant (GTL) is under construction
in Qatar. Pearl GTL, a joint venture between Shell Oil and Qatar Petroleum, taps into the North Field’s more than 900 trillion cubic feet of natural gas (15% of the world’s gas resources). First, impurities such as ethane and sulphur will be extracted and used for other purposes. Then clean gas (methane) will be converted to liquids. Amazingly, the process is based on Fischer-Tropsch technology developed in 1920s Germany. Since the Pearl plant is sited in the desert, which reaches more than 104 degrees, it will be self sufficient in water use. The GTL process produces water when the hydrogen in the natural gas reacts with oxygen.

• Battery power. A new generation of lithium batteries that recharge faster and produce more power, using technology developed at MIT, is being produced by A123 Systems, based in Watertown, Massachusetts. A123 cells are being used in power tools, aviation and, notably, hybrid vehicles that conserve fuel. Investors in the company include G.E., auto manufacturers, and venture capitalists.

With all the excitement and innovation, why aren’t more advisors developing an expertise in SRI?
Why the hesitation? For one thing, the crashing stock market has put advisors on overdrive to communicate
with clients and consolidate and maintain their base. In the past year or so, the tendency has been to be on the defensive. Why try something new in this uncertain economy? It's an accomplishment
to simply hold on to what we have.

Beyond the economy, though, advisors have other reasons to hold off on developing a niche in sustainable
investing. Some see it as a marketing ploy rather than a solid investment platform. Others believe - along with their clients - that investing with their conscience has to mean giving up a market return on their portfolios.

In addition, developing an expertise in SRI means putting time and effort into learning the new investment
process. Besides climbing a learning curve, advisors must incorporate SRI into client materials and an expanded investment platform.

Where is the investment coming from now?
The biggest investor by far is the Federal government, which will funnel funds to states for local investment. The February 2009 stimulus bill passed by Congress will fund almost $79 billion in clean energy projects and efficiency as well as green transportation. President Obama has linked the bill with creating or saving about 3.5 million American jobs; we are getting used to the idea of “green collar” jobs to supplement the blue collar sector.

Likewise, environmental issues are central to the 2010 budget that was just passed by Congress. For example, $150 billion is slated to be invested in clean energy industries such as wind, solar and geothermal
power. Almost $4 billion is allocated to America's water sources such as, our lakes and rivers.

As individuals, Americans are investing through the universe of SMAs, ETFs and mutual funds that incorporate sustainable investment practices. They have propelled the growth of sustainable assets to $2.7 trillion in 2007, up from $2.3 trillion just two years earlier in 2005.

In addition, endowments and foundations are putting pressure on money managers to meet sustainable and socially responsible criteria.

Bottom line: ROI, Return for Investors
Do returns on SRI actually lag the market? That might have been true in the past, but today – in the midst of this economic downturn – it is hard to make that case.

Using two sustainability indices, a new A. T. Kearney report produces convincing evidence that companies “committed to corporate sustainability practices are achieving above-average performance in the financial markets during this slowdown.”2

Kearney tested whether a company was simply giving lip service or genuinely engaged in creating a sustainable long-term business. Kearney examined 99 companies on the Dow Jones Sustainability Index and the Goldman Sachs SUSTAIN focus list. The authors defined sustainability practices as those that protect the environment, promote social well-being and achieve shareholder value.

Results showed that, during the current economic downturn, sustainable companies outperformed broader indices. Common factors include:

• A focus on “long-term health” vs. short-term gains. A diversity of strategic thinkers looked ahead five years and longer, and identified a mix of phenomena (such as shifting consumer demand and demographics) that would impact the company’s markets.

For one company cited, this meant increasing production by 76 percent in the past 10 years while reducing greenhouse gas. emissions, energy and water use.

• Sound risk management practices that are aligned with the company’s long-term strategies.
These practices include detecting potential weaknesses such as supply chain interruptions or international vulnerabilities.

• A true commitment to transparency and corporate governance, that is, a stringent process for overseeing management practices.

• A history of investing in green innovations, for example, using technology to reduce carbon dioxide emissions.

Another recent report supports the outperformance of SRI. Cerulli Associates says that SRI fixed-income funds "outperformed other fixed-income mutual funds in five of the past ten years."3

Perhaps the most convincing new evidence for SRI vs. traditional investing parity is this chart comparing
global returns on the Dow Jones Sustainability World Index versus Morgan Stanley Capital World Index. Over the ten-year period since August 1999, the two indices’ performance are virtually identical.

It’s easier than ever
As sustainable investing and SRI have picked up momentum – and as SRI portfolios have produced solid, competitive results – resources have grown in depth and breadth.

Recognizing the diversity and complexity of clients’ personal convictions, Envestnet’s enhancements mean that advisors can customize traditional portfolios with SRI overlay screens. Clients can choose from a “Best-in-Class Screen” or a more stringent “Strict Screen.”

Criteria include cruelty to animals, alcohol, tobacco, firearms, gambling and adult entertainment. Additional
criteria address military issues such as weapons and nuclear power. Personal beliefs such
as abortion and contraception are options. Clients can also screen for human rights and consumer
rights.

Looking forward
Despite today’s economic hardships and uncertainties, American creativity and entrepreneurial energy
are moving forward. Once the momentum is underway, there is no telling who or where the next
Microsoft or Apple will come from. It could be one of our energy-independent examples – Verdant
Power, WaveConnect, Pearl GTL or A123. Or it could be one of the thousands of startups or concepts that have yet to become visible.

Markets are always looking ahead. Perhaps advisors should do that too. Recognize that the future
will include sustainable portfolios, performing as well or possibly better than traditional investing.

 

1 “Ocean power surges forward,” Christian Science Monitor online, April 27, 2009, http://features.csmonitor.com/environment/2009/04/27/ocean-power-surges-forward/
2 “Green Winners,” www.atkearney.com/images/global/pdf/Green_winners.pdf
3 “Socially Responsible Funds Show Performance Resilience in Market Downturn,” Cerulli Associates, April 2009, www.cerulli.com/pdfs-pr/2009_SRI_Press_Release_1.pdf

 

This article contains no investment advice or recommendations and is provided for informational purposes only. Investing carries certain risks and there is no assurance that investing in accordance with the portfolios mentioned in this article will provide positive performance over any period of time. Investment decisions should always be made based on the client’s specific financial needs and objectives, goals, time horizon and risk tolerance. The statements contained herein are based upon the opinions of Envestnet and third party sources. Information obtained from third party sources are believed to be reliable but not guaranteed. Neither Envestnet nor its representatives render tax, accounting or legal advice. Past performance is not a guarantee of future results.

FOR FINANCIAL ADVISOR USE ONLY. NOT FOR USE WITH END INVESTORS.