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CLIENT QUESTION OF THE WEEK: How can I align my environmental views with my investment objectives?

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.

Exhibit 1

As of December 31, 2020. Greenhouse Gas Emissions Intensity represents a company’s recently reported or estimated Scope 1 (direct) + Scope 2 (indirect) greenhouse gas emissions in carbon dioxide equivalents (CO2e) normalized by sales in USD (metric tons CO2e per USD million sales). Greenhouse gases included are the seven gases mandated by the Kyoto Protocol: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF6), and nitrogen trifluoride (NF3). Potential Emissions from Reserves is a theoretical estimate of carbon dioxide produced if a company’s reported reserves of oil, gas, and coal were converted to energy, given estimated carbon and energy densities of the respective reserves. These methodologies are subject to change with data developments or other findings or events. Certain information incorporated herein has been provided by Institutional Shareholder Services Inc. (“ISS”), and by MSCI ESG Research Inc. (“ESG”). Although Dimensional Fund Advisors’ information providers, including without limitation, ESG and its affiliates (the “ESG Parties”), obtain information from sources they consider reliable, none of the ESG Parties warrants or guarantees the originality, accuracy, and/or completeness of any data herein. None of the ESG Parties makes any express or implied warranties of any kind, and the ESG Parties hereby expressly disclaim all warranties of merchantability and fitness for a particular purpose, with respect to any data herein. None of the ESG Parties shall have any liability for any errors or omissions in connection with any data herein. Further, without limiting any of the foregoing, in no event shall any of the ESG Parties have any liability for any direct, indirect, special, punitive, consequential, or any other damages (including lost profits) even if notified of the possibility of such damages. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
1 https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights
2 Dimensional’s approach to sustainability investing is protected by U.S. Patent Nos. 7,596,525 B1, 7,599,874 B1 and 8,438,092 B2.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale.