Chef Martin Picard's Au Pied de Cochon is my favourite Montreal restaurant. When I visited his maple sugar harvest event, it was a carnivore's paradise — four meaty appetizers and three mains. But he also offered a vegetarian dish.
I tell you this because investment professionals tend to be carnivorous. Any investment with the scent of upside is fair game. But some investors don't embrace traditional corporate values, and instead have social and environmental objectives. Today's advisor should develop strategies to address those needs.
Socially responsible investing (SRI) used to mean "no tobacco, alcohol, gambling, weapons and no apartheid." But sustainable environmental, social and corporate governance (ESG) activity has also become important. Some investors will exclude offending companies from their portfolios, while others prefer broader criteria, such as investing in best-in-class companies. So advisors will need to address these views.
The best way to construct a portfolio that meets a client's social and investment needs is to build it from individual securities. A diversified solution may require more capital than is available, so a little imagination is required. Consider buying a broadly diversified ETF and shorting the objectionable holdings individually or collectively. One positive consequence is that you may reduce risk without impeding returns.
There are now ETFs that reflect the growing demand for responsible investments. There are five U.S. choices and one Canadian in the broad ESG category and several ecologically specific choices (see "Socially responsible ETFs in North America," this page). Unique among these is the AdvisorShare Global Echo ETF that, in addition to seeking companies focused on sustainability in energy, technology and the environment, gives 0.40% per annum to Philippe Cousteau Jr.'s Global Echo Foundation.
The iShares Jantzi Social Index (XEN) excludes nuclear, tobacco and weapons manufacturers and holds 60 stocks that have been ranked for their environmental, social and governance criteria.
As of March 31, 2013, XEN had outperformed iShares S&P/TSX 60 Index Fund (XIU) for all periods with similar risk (see "Socially responsible ETF vs. broad equity indices," this page). But this is a broad index that may not satisfy every investor interested in SRI, so you need to be creative.
XEN holds shares of Suncor, Imperial Oil, Cenovus Energy and Canadian Oil Sands — all oil sands participants. And yet consider the controversy over the Keystone XL pipeline. Critics are concerned about the potential for oil spills and the expansion of oil sands production. This is partly because average greenhouse gas emissions for oil sands extraction and upgrading are estimated to be between 3.2 to 4.5 times as intensive per barrel as for conventional oil produced in Canada or the U.S., according to the Pembina Institute.
To avoid holding those companies, one strategy is to buy XEN and short the iShares Oil Sands Index (CLO) in proportion to the approximate energy exposure (20%). In this way, you achieve broad ESG participation less oil sands exposure. The returns of this strategy are shown in the table "Tactic to establish,".