Can impact portfolios be diversified?

A question we often get asked is ‘can you invest sustainably and still have a diversified portfolio?’ The assumption behind this question being that if you employ negative screens to ‘omit’ certain companies/ sectors aren’t you then limited by the number of investible opportunities within your universe? The reality is, there are a lot more impactful stocks than you might think. Within equities alone, the Tribe multi-theme medium risk portfolio currently contains over 400 companies held through funds in that portfolio and no company position size is greater than 1%. Furthermore, investing sustainably should lead to a better diversification of risk amongst better run businesses of today and tomorrow.

Some of the world’s greatest challenges offer some of the best opportunities for investors. There are three key tailwinds that support this belief: first, improving economics within the renewables sector, shifting consumer habits and rapidly changing global regulation. The economic factor is simple. Every year it gets increasingly more expensive to dig oil out of the ground and significantly cheaper to use renewables. We are at, or are approaching, the inflection point for sensible users of energy to start shifting to the cheaper option. Second, we are seeing a preference amongst consumers, especially millennials, to buy goods and services that have sustainability credentials attached to them – and this preference is only getting stronger. And third, regulation: over the last 12 months we’ve seen many reports come out from governments in the US, UK, Europe, China and India tied to their carbon emissions reduction plans and transition plans. This is going to drive infrastructure and broader investment for the next 20-30 years.

By being at the forefront of the sustainability revolution and by understanding these drivers, impact investing has the potential to mitigate many risks – for example climate risk or supply chain risks – that non sustainable portfolios may not be taking into account.

Fred Kooij, chief investment officer

With these considerations in mind, let’s take a closer look at portfolio diversification. As mentioned above, when thinking about sustainable portfolio construction some people may expect portfolios to have numerous exclusions and to be overly concentrated. However, the real question is – can impact portfolios be ‘sufficiently’ diversified? Sustainable investors may have slight biases to certain sectors, but not overly so, and as mentioned previously, they’re in sectors many believe will underpin the global economy going forwards.

There are really interesting investment opportunities in impact, from a sector diversification perspective. Existing sector classifications are a bit outdated and there are emerging technologies that are increasingly difficult to categorise. For example, a lot of the innovators in the clean energy space are classified as industrials, utilities or even technology companies: so as renewable infrastructure grows, there’ll probably be shifts in sector classification in traditional indices as they become more sustainable. It’s also worth restating that despite all the noise around sustainable investing not being able to invest in traditional energy, this sector only comprises 3% of the global index, and is continuing to shrink.

The other sector often asked about is financials. Whilst not to the same extent as other non-sustainable investors, sustainable investors can invest in some financials, and encouragingly, we’re starting to see some change in this sector. There’s an expectation that over the next few years there’ll be plenty of challenger opportunities in both energy and financials that should see the investable impact universe continue to expand.

Healthcare should also be mentioned here, a popular sector in the sustainable space. It’s a sector with large defensive value companies like big pharmaceutical companies and also innovative biotech companies with huge growth potential. For impact investors, the trouble is not finding enough names, but making sure to allocate to the right type of companies at different stages of the market cycle and understanding the sustainability credentials of those companies.

At Tribe, our investment philosophy is simple, as is its application – invest in well-run companies solving major global challenges. We don’t think impact portfolios should be run differently to traditional ones. When constructing our portfolios, we consider exactly the same factors as traditional managers. The difference is that we adopt a twin-lens approach where we look at both the financial and impact credentials of a company. This means you may see different funds or securities in the detail of a Tribe portfolio but at the top level, the asset allocation shouldn’t be widely different from what you would expect. As such, we prefer to compare ourselves to traditional benchmarks and our expectation is that our sustainable philosophy should drive long term sustainable economic growth.