As more investors show interest in responsible investment (RI) strategies, advisors can help them choose between mutual funds and ETFs, and between active and passive funds.
Responsible investment continues to grow in Canada, with assets totalling $2.17 trillion at the end of 2017, an increase of 41.6% over two years, the Responsible Investment Association (RIA) said in its latest trends report.
Within RI, retail mutual fund assets increased from $8.26 billion to $11.07 billion over the last two years, while ETF assets doubled from $97.9 million to $240.6 million. RIA’s Q3 performance report for mutual funds and ETFs shows there are approximately 264 RI mutual funds and 19 RI ETFs in Canada.
How do advisors decide whether clients should invest in RI mutual funds or ETFs?
The breadth of products offered is an important consideration, says Sterling Rempel, principal advisor at Future Values Wealth Management of Aligned Capital Partners Inc., in Calgary. Rempel considers geographic allocations, different asset allocations and investment style allocations (a matrix that considers top-down, bottom-up, value and growth investing styles) when building a diversified portfolio.
“We can build a well-diversified portfolio with mutual funds,” Rempel says. “We have more of a challenge to do that with ETFs at this point in Canada.”
Of the 19 ETFs, Rempel says only a few have been around for more than three years. Ten are actively managed.
Active versus passive management
Helping clients integrate environmental, social and governance factors (ESG) into their investments can involve a number of strategies, including buying funds that practice shareholder engagement, thematic ESG investing, impact investing and various forms of screening. Passive management doesn’t lend itself to all those strategies, says Ginny Arnott-Wood, associate portfolio manager with Arnott-Wood Wealth Advisory, Raymond James, in Burlington, Ont.
Engagement is a significant component of RI mutual funds, and that’s harder to do with passively managed ETFs, she says. An example of engagement would be a fund company working with a company to reduce its carbon footprint.
“It’s not us doing a screening and kicking out the ones that don’t fit or have a low score,” Arnott-Wood says. “It means being actively involved with those companies if the companies want to take suggestions and transition into a low-carbon environment. It’s effecting change by essentially working together with these companies, as opposed to just eliminating them because they don’t fit right now.”
While the lower fees of ETFs can be appealing, Arnott-Wood prefers active management when it comes to responsible investing. She buys stocks so she can screen the companies herself, and uses mutual funds to meet a specific mandate, such as fixed income or global equity.
Charlene Birdsall, a portfolio manager with Silicz Birdsall Advisory Group, National Bank Financial, in Winnipeg, also prefers mutual funds for their active management and potential for corporate engagement.
“The manager can exclude different stocks and lower the amount of exposure to different sectors, and still have pretty good performance,” Birdsall says. “Also, with a more concentrated portfolio, these managers will engage in targeting material ESG issues, whether through dialogue, proxy voting or public policy.”
ETFs provide a broader screening process to align a client’s values to the ETF—for example, an ETF that doesn’t invest in fossil fuels, she says. And they can also be less risky because they include a broader range of investments.
The biggest myth about RI is that investors have to forego returns when considering ESG factors, says Richard Nickerson, senior financial planning advisor with Assante Capital Management in Halifax, N.S. “Responsible investment has performed just as well or better in some markets than non-screened portfolios.”
The RIA report noted that performance concerns remain a barrier to RI investing while pointing to “mounting evidence to the contrary.” A 2015 Carleton University study found RI equity mutual funds in Canada outperform their benchmarks 63% of the time, while RI fixed income and balanced mutual funds outperformed their benchmarks 67% of the time.
However, while the rate of return is important for his clients, Nickerson says it’s not their main priority.
“I would say their ethics, social and environmental concerns are more important than the returns,” he says, adding there isn’t a specific number clients would be willing to accept. “I would say the majority of my clients would rather not own a company or a particular sector and have a slightly lower return than have a higher rate of return.”