Do you know what industries you’re supporting through your investment portfolio? These days more and more people are choosing to move away from the so-called “sin stocks” like alcohol, tobacco and gambling, opting instead to invest in companies with a track record of sustainability. My guest this week is Tim Nash, a fee-based advisor at Good Investing and founder of The Sustainable Economist. Tim explains why these days socially responsible investors should be thrilled by the many sustainable investment options they have at their disposal.

Welcome to the Maple Money Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. Are you afraid to invest in companies that are socially responsible? If so, our sponsor Wealthsimple can help you build a portfolio that focuses on low-carbon, clean tech, human rights and the environment. Get started with socially responsible investing by visiting maplemone.com/wealthsimple. Now, let’s check out Tim…

Tom: Hi, Tim, welcome to the Maple Money Show.

Tim: Thanks so much for having me on.

Tom: Here in Canada—well, everywhere I should say, it’s called socially responsible investing. But here in Canada, I kind of consider you the expert in this. There are not a lot of other people talking about it. I wanted to have you on just to go through this topic from beginning to end. The biggest question is what is this idea of socially responsible investing (SRI)?

Tim: That is a big question. There are lots of places I could go with that. But I’ll give you sort of the quick history and then the way I break it down. One of the problems is that there isn’t really consistent language. We don’t really have a strict taxonomy here so it means a lot of different things for a lot of different people. Socially responsible investments started in the Mennonite community here in Canada. It was really around this idea of religious investing. They wanted to get rid of “sin stocks” which are things like alcohol, tobacco, gambling, and pornography. A lot of the old school, very traditional funds and anything labeled as a socially responsible investment is probably going to (at the very least) get rid of those sin sectors. But really, it’s evolved tremendously over the last 20 or 30 years. More recently, the acronym that’s very popular is ESG, which stands for environmental social governance. Basically, now research firms—and there are two big research firms that do this. One is MSCI which is Morgan Stanley Capital Indices and another is, Sustainalytics. What they do is assess companies based on their environmental, social or governance scores. They kind of give them this sustainability score. And what’s cool is we found companies that have a higher ESG score actually outperform and have higher risk adjusted returns. What we’ve seen over the last little while is movement away from this idea of ethical investing where people assumed lower financial performance. A lot of people assumed that the “sin stocks” is where the money is. Now, what we’re seeing is by assessing companies based on their sustainability, leadership, and how far ahead of the curve they are on these issues is a way of identifying companies that are slated to do well financially. So the approach that I use is to break it up into two areas. I talk about doing less evil which is still investing in broad, global companies but getting rid of the evil things. And everyone has a different idea of what’s evil. The popular thing right now is fossil fuel divestment; people wanting to get rid of oil and gas and pipelines. But then also there’s this other area of what I would call “doing the more good” which is investing in things like renewable energy, clean technology, water infrastructure. There’s this growing field of impact investments which are really exciting. Things like community bonds, green bonds and microfinance. Now, these “doing more good” approaches are a little bit risky. They kind of come with their own sort of unique investment profile so I never suggest that people go all-in on these “doing more good” approaches. Instead, you still want to find that nice, balanced, diversified portfolio where most of your money is probably going to be invested in doing less evil stuff. Then you can carve out part of your portfolio for these “doing more good” options.

Tom: You mentioned these SRI options are outperforming markets. I’ve seen some charts of this that certainly follow the market but just a little bit above. Why is that? Because I kind of had the same opinion, too, that “sin stocks” must be pretty profitable. Is it just the way people are going now in that it’s not as cool to smoke as it was 30 years ago. Things like that.

Tim: If we talk about tobacco specifically, it’s about lawsuits. When you look at some of the legal implications—tobacco companies lied to us for a very long time about the connection between tobacco and cancer. Now, a lot of governments are going after them for health care costs. It’s an interesting thing. I did my thesis on this 10 years ago looking at the financial materiality of ESG issues. As it stands right now, it is much more from a risk perspective. Think about two investment managers. One of them is just doing the financial analysis, the very traditional financial metrics. The other manager is doing those same traditional financial metrics but in addition to that is looking at the company through this lens of environmental social governance issues. They have more information. They’re able to make smarter decisions specifically when it comes to a risk perspective. The companies that have these high ESG scores are simply better managed. Obviously, lower energy costs, water costs, material costs if they’re more efficient. Productivity is a huge one where employees want to work for companies. We’re seeing this a lot with students coming out of MBA programs where they really want to work for companies that are leaders in sustainability and will take a lower salary to do so. Then on the revenue side, customers are more loyal and often willing to pay a premium for organic, fair trade, ethically sourced goods. So it’s kind of a wide mix of things. When I looked at this 10 or 11 years ago, I looked at something like 300 different ESG indicators. And the one indicator that had the strongest correlation—I can’t promise causation, but the strongest correlation to financial performance was percentage of women on the board of directors. Companies with more than two women on the board of directors significantly outperformed companies that had an all male board or there was only one “token” female. So, yes, I could theorize about why that is. But needless to say, it’s the type of thing where managers looking at these ESG issues in addition to the financial issues, are just getting a fuller picture of what that company does.

Tom: Is this a bit different than this idea of greening where you might be taking on entire sectors? From an investing standpoint, not getting into the “do good” side but just strictly numbers, it seems like that could add risk where you’re being less diversified if you’re really just taking an entire sector. Any thoughts on that?

Tim: It depends on the sector. Something like tobacco is a pretty small sector overall. The interesting thing has been on the fossil fuel divestment. Energy has just been performing so poorly over the last 10 or 20 years. It used to be a huge part of the S&P 500. Something like 10 or 12 percent. Now it’s something like 4 percent. And I would argue it’s going to keep getting smaller. It’s the type of thing where we are very deliberately going underweight. Or in this case, a zero weight in specific sectors. So if those sectors outperform, then the portfolio is going to do worse. But if those sectors are higher risk of litigation of reputational risk of just straight up sector decline, then that’s where some of the outperformance can come in. There definitely is two different approaches. One is the negative screening where we just get rid of companies or sectors entirely. The other one is ESG integration. This is the one that’s definitely the most popular, especially when it comes to the big foundations, pensions and endowments. They’re now realizing there is alpha to be generated. That you can outperform by picking companies that have those higher ESG scores.

Tom: You mentioned there’s a couple different companies that come up with the ESG score. Can we go into how this works? I don’t want this to be a political episode, but does this come down to opinion sometimes? The governance one sounds a little—I’m not quite sure about how that works.

Tim: No, it’s all highly analytical so it’s all quantified. When it comes down to governance issues, it’s going to be things like separation of chair of the board and the CEO. The company I always point to as a fascinating case study is Facebook. Facebook has a decent environment score. It’s pretty high. They have a pretty good social score. They treat their employees well. They have a horrible governance score. When I look them up (on Yahoo Finance) Facebook has a little sustainability tab over to the right where you can see a zero with percentile. In the tech space, Facebook is the worst governance score. Mark Zuckerberg is both CEO and chair of the board. Now, the number one job of the board is to hire and fire the CEO. So obviously, there’s a bit of a conflict there. As well, a lot of these tech companies tend to not issue voting shares. They issue non-voting shares so that shareholders don’t get a say. It will be things like, is executive compensation tied to sustainability metrics where the companies compensation is tied to something like the carbon footprint are going to care more about these things. Also, it is going to look at that percentage of women on the board of directors. So additionally, it will look at things like tax paid per country. If there are a lot of tax shelters they’ll get dinged for that. It’ll look at things like political donations. That’s where I would say it does get a little political where companies that are donating a lot of money (regardless of the party) are going to have a the worst score. Those are all different governance metrics. When it comes to these things, it can be a little bit tricky. I always point to an interesting example which is Nestle. Nestle has a really good ESG score. They’re considered one of the top Swiss companies with a very high ESG score. But the number of Canadians I meet that just absolutely can’t stand Nestle are saying, “No, thumbs down. Not one penny into Nestle.” A lot of people just really kind of ethically hate that company even though they have a good ESG score. So it’s the type of thing where it does give me the data and that quantified ESG. And it’s really around policies and procedures. But ultimately, everyone’s going to have their own opinion and their own personal line in the sand about the types of companies they want to exclude.

Tom: I kind of made to go backwards by leading with governance. Can you cover those other two similar to what you just did? How is the environment one made up?

Tim: Environment is going to be a lot of policies. Is there a hazardous waste policy? Did they have a target for renewable energy consumption? And then are they on track to meet those targets? It’s going to be looking at things like water use, the amount of waste that’s generated and it does vary sector by sector. So obviously, in the mining sector, things like tailings and affluence is going to be much higher. Whereas, in a lot of other sectors it really does come down to environmental policies. I don’t know if you know about ISO standards which is International Standards Organizations?

Tom: I’ve heard of them. I don’t understand the whole thing with all those different numbers and stuff.

Tim: Yeah, there’s a whole bunch of them but I think ISO 9001 is environmental standards. What we’re really looking for here is does the company have these policies and standards in place? Are they performing audits to ensure those standards are being met? And then, what is their performance on important issues like carbon footprint, water use, etc.?

Tom: What are the pieces that make up that?

Tim: The social one is a lot to do with the employees. So it’s going to be a lot of things like a percentage of the workforce that’s unionized. You get a higher score if you’ve got unionized employees. A big issue that comes up is the supply chain. Think about a company like Apple. They got nailed a few years ago because they use a supplier in China called Foxconn. And Foxconn—it was horrible. They were working people so hard that employees were committing suicide by jumping out of the office building. They had to put up nets because so many people were jumping. They were atrocious working conditions. And with Apple, their thing is like, “Well, that’s not us. It’s this other company.” But they hired them. Now, it’s looking at how you treat your employees but also the supply chain and how they’re treating their employees. Again, are there standards in place? Are there audits to ensure that those standards are being met? Then it’s going to be things like lost time incident ratios. There is a score for employee fatalities. It’s really looking at the nitty-gritty on the employee side of the equation. Are company is treating their employees fairly?

Tom: It’s definitely fair. It makes sense. Maybe that one’s the one that probably hurts the returns the most. That doesn’t make it right at all. But with unions is that company more profitable? Maybe not. But they probably keep their employees longer. There might be less turnover and all that.

Tim: That’s the key thing. It’s the turnover because the cost associated with hiring and training a new employee is crazy high. And also, productivity is a key measure here. So again, I think we kind of have this capitalist notion that the way companies make money is by exploiting people and by exploiting the planet. That’s how you maximize profits. But honestly, that’s not true. In all my studies, what it shows is companies that treat people and the planet fairly; if you’re more efficient, more productive and more innovative, you make more money in the long-term. And a big reason for that is that you also avoid those reputation risks. Think about Nike getting nailed for the sweatshop scam. Think about Volkswagen getting nailed for that emission scandal. Companies that cheat, lie and exploit, when they get caught, their stocks take a nosedive. The big thing here is about risk mitigation. You can’t always avoid all the risks. Like with Volkswagen. It doesn’t matter how much research you did. They had a pretty good ESG score. They were just straight up lying. What we’re finding is that it’s better to have this information than not have this information.

Tom: It seems like the more we had as a country and a world as to being more environmentally responsible, the more it should actually pay off. It’s no different than our own personal situations. I’m a huge fan of things like going solar and saving money. It’s about the money as much as the environment you can kind of improve.

Tim: Totally. That’s it. These things have really outperformed over the last decade. There’s evidence there. And when I look forward over the next decade, I expect regulations to become more stringent. And especially around climate change. As we start to see carbon pricing, if we’re serious about moving towards a low-carbon economy, companies that are ahead of the curve and have already taken steps to lower their carbon footprint, I expect them to continue to be more profitable and outperform the laggards.

Tom: It’s definitely the direction we’re going in. So it seems like this form of investing probably puts you a little bit ahead of the curve. And I totally agree that the gap could increase more. These companies have to do all these things. They have to be a better employer. They have to be more environmentally responsible.

Tim: I’ll be very Canadian and say, “We need to skate to where the puck is at.”

Tom: Yes, exactly. How can someone get started in this? I know there’s tons of options. ETFs and robo-advisors. You mentioned stock screening, one-on-one stock. Can you go through all these different options?

Tim: There are so many options now which is fantastic. When I started my blog in 2010, 2011, there were so few options. It was really tough to find them. But there are mutual funds. There are ETFs, robo-advisors. Wealthsimple does have a socially responsible portfolio. I think it’s so great that they’re now offering them. I think it’s something like 30 percent of Wealthsimple clients are ticking that box. And my guess is that as more people and there’s more evidence that it does just as well, if not a little bit better. My dream is that Wealthsimple will make that the default portfolio. Thirty percent of people will tick the box saying they don’t want that.

Tom: I want the sin stocks. Yeah. (Laughs).

Tim: It depends on your investment style, on your investment approach. Really, the starting point is just to ask questions. Whoever your provider is, ask if there a socially responsible option? The one thing that investors do have to be careful about is that there sometimes is a little trade-off when it comes to fees. Oftentimes, fees for these socially responsible funds are a little bit higher. It’s kind of like buying the organic food in the grocery store. I think they feel they can get away with charging the tree-huggers just a little bit more—a little premium for that. That said, Vanguard just came out with some ETFs last year that were so cheap. I think it was something like 12 basis points or 15 basis points for those. So as there are more options, I expect more competition. I expect the fees to come down. But especially with the mutual funds, they already have high management expense ratios. I know Larry Bates likes to complain about that and I’m on the same page as him. Sadly, the socially responsible mutual funds are even more expensive. Again it’s because of that premium. So you want to keep an eye on that. But really it’s about asking questions. See if there is an option that is available. For people who are working with an advisor, I’ve just heard so many stories from people who ask these questions. They talk to their advisor who just doesn’t know very much about this topic and frankly tries to talk them out of it. I’ve heard people come out of those meetings being laughed at. They’re being told they’re going to throw all their money away trying to make the world a better place. But, no, no, no, this is a very rational thing to do. I think a lot of the traditional advisors here in Canada just don’t have knowledge when it comes to this and will readily dismiss these concerns. I always like to remind people that it is your money. If the person you’re talking to doesn’t have an option for you, then take your money elsewhere and find a place where they will work with you and find something that is in line with your values.

Tom: Going back to the fees, I don’t think it’s just tree huggers. I think every time you want to go away from the biggest version of an ETF or mutual fund, anytime it kind of niches down, they’re going to charge you an expense for that. So it doesn’t seem to matter. If you start getting into smaller ETFs like a tech ETF or something like that is when they nail you.

Tim: My hope is that as more people clue into the fact that you can actually make more money by investing responsibly, we’re going to see those assets under management start to climb up. My dream is that this does become the default way for people to invest. In that case, fees would come down quite dramatically.

Tom: With an ETF, mutual fund or robo-advisor, how much of a portfolio are we excluding here? Is it still roughly three quarters of an index? Just generally speaking.

Tim: It really depends. There’s a really wide spectrum in terms of this ESG integration. I would say one step in the right direction would be something like those Vanguard ETFs where it’s still the entire universe. They’re just getting rid of alcohol, tobacco, weapons, pornography, gambling. And they do get rid of oil and gas companies. Although, they still include pipelines. iShares has CRBN which is the ACWI (All Country World Index) low-carbon target ETF where, again, they’re just getting rid of oil and gas and skewing the weights based on carbon footprint. But that one’s still going to have tobacco and weapons in there. It’s really just low-carbon focused. All the way to now where there is a vegan ETF that’s on the market. That’s going to get rid of a lot of consumer stuff. So food companies, grocery stores, pharmaceuticals and beauty products because they do animal testing. I would say the most stringent that I’ve seen would be something like the Horizon’s Global Sustainability Leaders. ETF ETHI which is actually here in Canada gets rid of a whole whack. I have to catch my breath halfway through the screens just because it’s very comprehensive. That one is going to be one of the least diversified. It’s only got about 100 large cap companies in there. That would be a fairly small fraction of the overall universe. Whereas, with some of them, it’s going to be 98, 99 percent of the universe. It’s really understanding there is a broad spectrum here. Everyone’s going to have a different definition of what this means. The approach I use with my clients is to kind of get a feel for where they are on that spectrum. I have a couple questions I ask that kind of give me those clues. Once I get a feel for where they’re at, then kind of showing them two or three or four different options and talking through the methodology but then also looking at the companies. What I love about ETFs is the transparency. With mutual funds, they don’t give you the full list. They only give you the top 10. I have to dig through the financial reports to get a snapshot from six months ago. Whereas, with ETFs I click on two buttons and I get the full list of holdings. We scan through those holdings and see whether there are any companies that might have snuck through the methodology where people are absolutely thumbs down about. By understanding the methodology and then going through the companies gives people a really strong understanding of what’s actually inside the ETF. Then they are able to make the decision based on the trade-offs, diversification, fees, whether it’s in U.S. dollars. Those are the normal trade-offs that are involved here. They can decide where they want to land. I’ve stopped projecting my values. For the first little while when I was doing this, I was telling people, “Here’s how you should do it…” I’ve kind of gotten over that. Now I say, “No, no, no, I’m going to leave my values at the door. It’s really about what is your definition of responsible or ethical or sustainable. Let’s create a portfolio that lines up with your definition.” That way, I leave my judgment at the door.

Tom: I think it’s been a great run through of everything with socially responsible investing. Can you let people know—I think there’s a few places where they can find you. But give it all to them. Let them know where they can find you.

Tim: For your listeners, probably the best resource is going to be my blog, sustainableeconomist.com. That’s kind of for the nerds. I’ve got my model portfolios up there and that’s where I’ve put a lot of my research there for free. The way that I’ve made a living doing this is I’ve become a fee-for-service financial planning. I rebranded a couple of years ago as, Good Investing. People can go to goodinvesting.com where I offer everyone a free consultation. What I do is basically get paid by the hour to help people through a process and manage their own money with that DIY approach. I’m on Twitter at @timenash. Those are probably the best places for people to find me.

Tom: Great. Thanks for being on the show.

Tim: Thanks so much for having me on.

Thanks Tim, for showing us how we can get ahead with socially responsible investing. You’ll find the show notes for this episode at maplemoney.com/timnash. If you enjoy listening to the Maple Money Show on Apple podcast, please take a moment to give us a rating and interview. Anyone who leaves a review in November can enter a draw to win a signed copy of the book, Retire Inspired, by Chris Hogan. Head to maplemoney.com/review for instructions and to enter. Be sure to tune in next week when Richard Moxley is my guest. We’ll be discussing how to improve your credit score.