Investors around the world are increasingly aware of how certain business practices may potentially affect the environment and how that may impact future generations. As citizens, individuals can express their political preferences around sustainability through the ballot box. As investors, they also can express their preferences through participation in global capital markets. Recently, we've seen investors putting their dollars to work - in Q4 2020 we saw a record $20.5 billion flow into sustainable funds, doubling the previous record for a quarter. For the past five quarters, sustainable fund flows have averaged nearly $12 billion per quarter, far more than had been the prior norm.1
As demand in the space has increased, the solutions available on the supply side have increased in order to meet that demand. And while more solutions have come to market, it's important for investors to be aware of and evaluate the different approaches managers may take to accomplish what seems like the same goal.
We believe a great starting place is to build broadly diversified investment solutions that emphasize what research indicates are reliable sources of higher expected returns while also aiming to minimize unnecessary turnover and trading costs. However, it’s not enough to just have a strong investment solution when pursuing sustainability goals, you need to understand the environmental issues that are at the forefront of investors’ minds. For us, this means consulting with leading academics and scientists in ESG-related fields (Environmental, Social and Corporate Governance). This allows us to develop more robust investment solutions that seek to address the issues most important to environmentally focused investors without compromising on sound investment principles.
Due to the multitude of ESG practices that can be analyzed, it's important for a strategy to focus on well-defined goals and create a standard for measuring outcomes. Dimensional Fund Advisors (DFA) approaches sustainability investing in a focused way by considering how company business practices may impact the environment and whether these actions may impact the ability of future generations to meet their own needs. Rather than considering dozens of variables, DFA’s sustainability approach focuses on climate change and seeks to reduce exposure to greenhouse gas emissions, which have scientific consensus as the main drivers of climate change. Using their US Sustainability Core 1 portfolio to illustrate the reduction in exposure to greenhouse gas emissions and emissions from reserves, Exhibit 1 shows the impact that DFA can have.
When designing sustainability portfolios, many investment managers use a binary “in” or “out” screening process which can lead to diminished opportunity for diversification and may reduce the reliability of capturing higher expected returns. DFA’s patented approach2 is designed to preserve diversification across the portfolio and within sectors while accounting for the reality that some sectors tend to be more significant contributors to emissions-related environmental concerns.
By starting with a robust investment framework, then overlaying the considerations that represent the views of sustainability-minded investors, this allows for a cost-effective approach that provides investors the ability to pursue their sustainability goals without compromising on sound investment principles or accepting lower expected returns. Today, you can eat healthy while also enjoying a great meal. In a similar way, investors can support their environmental values while maintaining sound investment principles, such as broad diversification and cost management, and pursuing higher expected returns.
Since DFA’s first sustainability strategies were launched in 2008, they’ve been able to expand their offering to allow investors to develop a fully sustainable portfolio with exposure to the US, developed ex US, and emerging markets in both the equity and fixed income space. Dimensional’s full suite of sustainability investment solutions allows investors to customize their portfolios with a consistent sustainability approach throughout.