Should you ever wake up in the night thinking the world is a big, screwed-up mess and you’d rather not add to it anymore than you already do1, then know that you are not alone.

SRI investing – variously known as Socially Responsible Investing or Sustainable, Responsible, Impact Investing – is a growing market movement, enabling investors to put their pounds into the collection boxes of the good versus the G-strings of the bad.

By choosing an SRI-themed fund,2 you are buying into firms with a positive environmental, social and corporate governance (ESG) agenda [Caveat Alert] while steering clear of sleazy capitalists who profit from gambling, porn, booze, fags, guns, and generally exploiting the planet and its denizens [Caveat Alert].

Hold up. What’s all this ‘Caveat Alert’ business?

Well, it turns out that investing on behalf of your conscience is no simple matter. It requires you (or someone else) to make active choices about what counts as vice or virtue.

• Do you think genetic engineering is bad? Nuclear energy? Alcohol? Soft drinks? Some SRI funds screen out these industries. Others don’t.

• Do you want your fund to just avoid the bad (called negative screening) or do you want to reward the good (positive screening)?

• Is environmental sustainability your banner cry, or do you want to invest according to your faith?

And what about a firm that’s good and bad? Say a company is really good at employing a diverse workforce with generous pay packages – but really bad at resisting the temptation to strip-mine virgin rainforests?

Do you want your fund to be an active shareholder that lobbies management to work harder at not screwing over their workforce, employing children, contaminating the water supply, avoiding tax, corrupting local politicians…

SRI is a broad church. And you can just invest in a fund that slaps a friendly label on – like an egg box that claims its chickens are deeply-loved – or you can do some digging, and find out who you’re actually supporting.

Choosing SRI funds

Fortunately there are some people out there who can help you navigate the moral maze.

At the very simplest level you can stick ‘SRI’ into Morningstar’s search box3 to dial up a list of funds and ETFs designated ‘SRI’. You can then invest in a vehicle that’s a sweet-smelling version of one of your regular asset allocation picks.

For example, you’d stop stinking up the place with a standard global equity fund – neck deep in fossil fuels, cluster bombs, and god knows what else – and replace it with a global equity SRI fund instead.

Job done. It only remains to celebrate with an Uber ride down the pub, puff on a big Cuban and test-fire some nukes using a coal-powered launch system.

Alternatively, you can refine your choice by paying some attention to Morningstar’s Sustainability Rating and Sustainability Score. These metrics are meant to indicate how well the companies in a fund walk the ESG walk in comparison to the holdings in similar funds.

The Sustainability Rating can be found on a fund’s overview page on Morningstar, and as many as five globes can be awarded for good behaviour. The globes look like this:

But how do you know whether companies really are playing nice? Well, let’s just say the level of scrutiny is not going to be up there with St Peter at the Pearly Gates or even Santa’s Elf On A Shelf.

Like buying Fairtrade chocolate, a lot must be taken on trust.

For example, companies are partly ranked according to their own documentation of their ESG policies. Performance measures like absenteeism and staff turnover play into their social rating. Carbon footprint can feed into the environmental side. The more you think about it, the more you realise that independently verifying this data must be a nightmare.

It’s also interesting to note that the company – Sustainalytics – whose data underpins the ratings does not seem to win many rave reviews from its former employees on GlassDoor.

That said, the metric enables us to see that, for example, the iShares MSCI Emerging Markets SRI ETF gets a Sustainability Rating of five globes. That puts it in the top 10% of funds for ESG in Morningstar’s Global Emerging Market Equity category.

Meanwhile, iShares Core MSCI Emerging Markets IMI ETF only gets two globes. That puts it in the bottom third of the Global Emerging Market Equity category.

You’ll notice the latter ETF is not SRI-focussed. Yes, Morningstar’s Sustainability Rating enables you to gauge the ethical tilt of funds that are not explicitly SRI. That’s handy because it allows us to cast our net wider. We can try to still invest in the most diversified funds while balancing our desire to make a difference.

Also note that all this globage tells us nothing about how funds compare against any other category. Five globes in Emerging Markets may not be as virtuous as three globes for a Clean Energy fund in the Equity Alternative Energy category, for instance.

And if a fund doesn’t notch a single globe then it doesn’t mean you’re investing in a bunch of companies with Sith Lords for CEOs. It simply means there isn’t enough data to generate a meaningful rating.

The long morality tail

If you want to shine a brighter light on your options then try Fund EcoMarket. Its search tool helps you find funds on all points of the moral compass (except the one that points down).

Tick a box if you want to tilt towards:

• Social or green themes
• Animal testing policies
• Oil, gas, and coal exclusion
• Shareholder activism
• Voting record transparency

These are just examples of the site’s breadth. It does an excellent job of breaking down and explaining the many granules of SRI.

So who are the moral guardians behind Fund EcoMarket? You can read all about them, but in short they are sponsored by wealth managers and fund providers who offer SRI services. Which makes sense because it’s not easy to research SRI investments right now. They freely admit they supply information as it’s provided by the product providers and I didn’t feel unduly funneled towards the sponsors’ products. In fact it’s the most useful UK SRI site I’ve found so far.

Fund EcoMarket’s search tool enables you to tick for index funds but it doesn’t currently include ETFs. As in the amoral fund space, SRI funds are dominated by active management, which is fine if you personally accept that’s a price worth paying.

Passive investors will be better served using the Morningstar link above and justETF’s search tool with the social / environmental dropdown activated.

Here you can pour over specialised trackers like the Amundi MSCI World Low Carbon ETF or the iShares Dow Jones Global Sustainability Screened ETF. Remember that niche ETFs are risky because they are liable to concentrate on a narrow range of companies or sectors. They probably shouldn’t be more than a 5-10% complement to your portfolio and are not a replacement for broader asset classes.

The US market tends to innovate at a faster pace, so if you’re truly passionate about certain causes then you could research American products like the SDPR SSGA Gender Diversity Index ETF via platforms such as DeGiro or Interactive Brokers.

But be aware that going off the beaten path can take you deep into the woods and requires a level of research way beyond the scope of this article.

The wages of sin

I’ve deliberately left to last the really big question: Whether good can triumph over evil in a, y’know, Earthly riches sense.

Surely the Dark Side is the quick and easy path to financial freedom?

Well, unless the Minions of Evil are the ones doing all the research it’s impossible to give you a straight answer. The literature cuts both ways and much depends on how you mine the data. Sometimes the saints can beat the sinners, but the most likely story according to financial theory is articulated by the renowned trio of Dimson, Marsh, and Staunton from the London Business School.

These academics reviewed several SRI studies for their Credit Suisse Global Investment Returns Yearbook 2015 and declared:

We show in this article that ‘sin’ can pay, not least because those choosing to exit ‘sinful’ stocks can cause them to offer higher returns to those less troubled by ethical considerations.

However, the expected financial impact of modest exclusions is generally small. We also provide evidence that corporate engagement can pay, whether the focus is on environmental and social issues or on corporate governance.

You see, as with any risky investment, if enough investors shun a firm you can expect its share price to fall below its fundamental value. This sets the stage for future excess returns. Even if the saintly investors continue to reject vice, Dimson, Marsh, and Staunton theorise that:

If the ‘sin’ discount stays constant, the expected capital gain is the same for sin and non-sin stocks: the excess returns to sin stocks should then come in the form of higher dividends over time.

In other words, you pay a lower price for the dividends of sin which should improve your returns versus less dubious shares.

Yet even those who pursue Earthly pleasures should know that shareholders can drive returns by forcing management to clean up. Improved corporate behaviour lowers perceived risks, which means that reformed companies:

[Are] likely to attract additional investors, avoid environmental and social mishaps, and sell at a higher multiple.

Which according to Dimson, Marsh, and Staunton could lead to an interesting SRI strategy:

A large investor can generate continuing outperformance by buying non-responsible companies and turning them into more responsible businesses. After they have been cleaned up, the shares may then be sold at a price that reflects the accomplishments of the activist.

Whether or not you think this motive springs from the purest of ideals, it does suggest that SRI investing can make a positive difference to the world without leaving you poor as a church mouse.

Can you put a price on your principles?

Just in case you think all this socially responsible stuff is a bunch of hippy crap, Morningstar quotes figures that estimate 30% of global managed assets were devoted to sustainable investing in 2014.4

It’s an area we’ve been asked to write more about by dozens of readers over the years, too.

The sight of human beings coming together to change the world is truly moving. It may be slow, it may be imperfect, but it is happening.

However, the purpose of this piece is not for me to tell you what to do. It’s to tell you what you can do.

Take it steady,

The Accumulator

P.S. This SRI business has more labels than a Formula One driver’s jumpsuit. Here’s an non-exhaustive list. Please add any more you find in the comments below!

• • Social investing
  • Responsible investing
  • Sustainable investing
  • Green investing
  • Ethical investing
  • Impact investing
  • Socially conscious investing
  • Socially responsible investing
  • Earth Mother investing

(I may have made one of these up).

1. …living your life of Western decadence at the nexus of a vast network of exploitation and inequity just so you can buy cheap trainers and neck chicken McNuggets in front of a giant TV that broadcasts more colours than you can actually see! AAAAARGH! [*Blows brains out*] [↩]
2. I’m going to use the term ‘fund’ as a catch all for diversified collective investment vehicles including ETFs and Investment Trusts, but not just passive products, throughout this piece. [↩]
3. Morningstar is a reputable financial data firm that provides useful tools for finding funds. [↩]
4. See page 42. [↩]

Some links that caught my eye this week.

Readers, I’ve got the blogger blues. Luckily for you I haven’t got my guitar out. But most days for a while now…

I’ve woken up in the morning
Got over to my desk
Had an overdue post on Lifetime ISAs or tax or whatnot
Wanted to do something else instead
Baby, I got them blogger blues…

This is not surprising. Monevator will be ten years old this summer, and I recently wrote my 1,000th article. I’ve never committed to anything this long, except peanut butter and phoning my mum once a week.

I was going to widen out this tale of woe – our plunging ad revenues due to high mobile usage and ad blocking, the long absence of The Accumulator as he writes our book, my failure to turn Monevator into the next MoneySavingExpert, a friend recently hospitalized from stress due to overwork – but that’s all by-the-by.

Bottom line: Something has to give to keep this ship afloat with everything else going on.

And Weekend Reading is it.

Why Weekend Reading is changing

For nearly ten years I’ve been at my desk by 8.30am on Saturday to finish this link roundup, which in practical terms has meant mostly no going out late on Friday and working for most of the past 500 Saturday mornings.

I’ve enjoyed it a lot, but I can’t overlook the times I’ve worked from hotel rooms or friends’ kitchen tables – or much more often stayed at home instead of taking that weekend break in the first place.

Most posts can be queued in advance, but topical links can’t. That puts the cosh on spontaneous holidays. I could just skip the links every few weeks, but I’m a do-or-don’t-do sort.

Other reasons to put Weekend Reading on the chopping block:

Tomorrow’s fish and chips paper: Many of you love the links – this is by far the most popular kind of article in terms of initial impressions. But after a week nobody is reading. Other articles can be delivering value for years. I’m instinctively an investor, and these links are more like a cash crop.

Nobody does this anymore: When I began blogging a gazillion years ago, Facebook wasn’t a thing and your social network was the people you’d buy a pint. Now almost no one does link lists. Very few sites even link out anymore from any articles. I’ve deliberately tried to support the best new UK investing blogs, but with a few exceptions (you know who you are! 🙂 ) not many sites send traffic here. At best most linking is on Twitter now.

The rest of Team Monevator cowers before it: An obvious solution to get me the odd weekend off would be to outsource the roundup to other writers. But it might as well be radioactive – it’s just too daunting to keep abreast of 100-odd websites each week.

It’s grown too big: Totally my fault. It means it takes several hours to create but more to double check. I’ve been a stickler for tidy formatting, too.

Now you know the background, here’s how it’s changing.

Weekend Reading is dead. Long live Weekend Reading!

I did consider scrapping Weekend Reading entirely, but two minutes with Google Analytics shows many thousands of people would be disappointed.

And what’s this blog for if it’s not to create a useful resource for many thousands of people?

Instead, a compromise:

Post links on Friday afternoons: This gives me my Friday nights back, and enables weekends away. A big win. It does mean we’ll lose the Saturday morning paper links.

A more idiosyncratic list: I can no longer claim this will be a comprehensive review of the Internet’s best money stories. Rather, it’s articles I’ve read and found useful.

Less formatting: I’m ditching nice bullet points and all but a few big sub-categories. Sounds trivial, but will probably save an hour.

More personalised: From now on I’m going to try not to write big prose intros (like this one) for Weekend Reading, but rather get straight into the links. However I’m also going to editorialize a bit more. Some of you will hate this, but others may find it more interesting (including me!)

Less blog promotion: With regret I will dial back the traffic I deliberately send to smaller blogs in order to save time and attention. I will still read them, and try to highlight their best articles.

Team Monevator: I’m hoping doing a shorter list (5pm update: I’ve failed this week!) that’s produced on Fridays might help me recruit someone else to do the job every few weeks.

This explanation might seem a bit self-indulgent. Who cares? Show me the links already!

However some of you have been reading Monevator for nearly a decade, and I know from your emails that perusing Weekend Reading has become a ritual. So I wanted to explain why it’s changing.

Hope you understand, and have a great weekend!

[continue reading…]

This article about time horizon and asset allocation is by former hedge fund manager Lars Kroijer, an occasional contributor to Monevator. He also wrote Investing Demystified.

Previously we’ve discussed how you should choose the minimal risk asset that will form the bedrock of your portfolio. The short version: If you have high-rated government bonds available in your base currency, they will typically be the best choice.1

Today we will look at the time horizon of your minimal risk investment, what returns you can expect to make, and how best to buy it.

Match the time horizon

In most discussions about minimal risk investments, the assumption is you’re talking about short-term bonds. Longer-term bonds have greater interest risk (i.e. they fluctuate in value with changes in the interest rate), and it’s not clear that all investors need to take that risk.

Consider a one-month zero-coupon bond and a 10-year zero-coupon bond that both trade at 100. (Zero-coupon bonds are a particular kind that don’t pay interest, only the principal back at maturity).

Suppose market interest rates suddenly go from zero to 1%. What happens to the value of these bonds?

As you can see, the one-month bond declines only a little in value to reflect the higher interest rate of 1%. This bond matures in just a month, and at that point the bond holder will be able to reinvest their principle at higher prevailing rates if they want to.

In contrast, the 10-year bond declines to a value of around 90.5 as it reflects the higher interest rate. Clearly something that can go from 100 to 90.5 fairly quickly is riskier – even if the probability that you will eventually be paid in full has not changed.

The time horizon for the vast majority of investors exceeds the maturity of a short-term bond, however. Also, someone who is interested in maintaining a position in the minimal risk asset for five years will be taking an interest rate risk over that five-year time horizon, whether they’re buying new three-month bonds every three months, or buying a five-year bond and holding it to maturity.

Finally, the situation is dynamic. If your time horizon is such that you think five-year bonds make sense, you shouldn’t necessarily just buy a five-year bond and hold it to maturity. A year hence, your bond would only have four years to maturity and therefore no longer match your time horizon.

The best way to address these issues is not for you to constantly buy and sell bonds to get the right maturity profile (in my example selling the now four-year bond and buying another five-year bond), but rather to invest in the bonds through a product like an ETF or investment fund that trades the bonds for you.

Such funds offer exposure such as ‘Germany 5–7 years (to maturity) government bonds’, ‘UK 10–12 year government bonds’, and so on. Buying one or a couple of these products to match your desired minimal risk asset and maturity profile is a cheap and easy way to ensure you always have your chosen minimal risk exposure.

Investors with a longer time horizon should buy longer-maturing minimal-risk bonds. As a reward for taking the interest rate risk associated with longer-term bonds, you’ll typically enjoy a higher return than you’ll get from short-term bonds.2

Go longer to reflect your investment horizon

If you need a product that will not lose money over the next year, then you can pick short-term bonds3 that match your profile.

However if – like most people – you want a product that will provide a secure investment further into the future, choose longer-term bonds and accept the attendant interest-rate risk.

Here you should consider the time horizon of your portfolio and select the maturity of your minimal risk bonds accordingly.

If you are matching needs far in the future (such as your retirement spending) then there is certainly merit in adding long-term bonds or even inflation-protected bonds to your portfolio.

Long-term bonds compensate investors for interest-rate risks by offering higher yields. You also have the further benefit of matching the timing of your assets and needs.

You can also mix the maturities of your minimal risk assets. You may have some assets that you won’t need for decades, and others you think will be needed in five to seven years, say. In that case, there is nothing wrong with picking a couple of different products with different maturities to match that profile.

What will the minimal risk bond earn you?

Even people with only a peripheral interest in finance know that interest rates are near historical lows. Nobody should expect to make a lot of money investing in the minimal risk asset in any currency right now.

In fact, with nominal interest rates near zero, inflation means that investors in short-term government bonds will experience negative real returns.

While your $100 invested in a government bond will almost certainly become $105 in five years’ time, the purchasing power of that $105 will be less than that of your $100 today. This is, of course, still better than if you had held the $100 under the proverbial mattress for five years – in that case the purchasing power would be even lower.

There’s not a lot you can do about this. If you are after securities with minimal risk then the yields are just very low at the moment. At the time of writing, cash with FSCS protection may be a better option for private investors, as we discussed last time. (Over the long term, returns from cash have historically been lower than from bonds, on a market wide view).

Elsewhere, instruments that offer much higher returns come with more risk of not getting paid. Anyone who tells you otherwise is not telling you the whole story.

The chart above shows what US government bonds (so in $) will currently earn you, by maturity, both in real and nominal terms (you can easily find it for other currencies if you Google ‘£ Government bond yield curve’, and so on.).

You can see, for example, that if you buy a 20-year US government bond, you can expect to earn just under 1% real return per year . Likewise, for a five-year bond you can expect just over a zero percent real return per year. (Five-year US government bond returns yields have actually been negative for much of the recent past.)

While the outlook for generating very low-risk real returns is fairly limited at present, these are continuously moving markets. Keep an eye on them as rates change.

Nominal yields, real yields, inflation, and taxes: The previous chart also shows you the current market expectation for future inflation. (It’s the difference between the two lines.) If the markets are assuming there will be roughly 3% annual inflation in the US for the next 25 years but only around 2% for the next five years, this suggests higher inflation in the longer term. Inflation is bad for many things, one of which is tax. While the benefits you get from your investments are based on real returns and the future purchasing power of your money, you pay taxes on the nominal return. Suppose you invest $100 for a nominal return of 2% the following year. You could be liable for tax on your $2 gain, even if 2% annual inflation had eroded the real gain4. Compare that to a zero inflation rate environment. With a 0% nominal and real return, your $100 would still be $100, both in real terms and nominally, at the end of the year. And there would be no gains to be taxed on!

If the previous chart gave you the sense that the return you’ll get in any one year from owning US government bonds is stable, reconsider.

The next chart shows the annual return from holding very short-term (less than one year) and long-term (more than ten years) US bonds since around the Depression.

As you can see the annual returns move around a fair deal for both kinds of bonds – but far more for the long-term bonds. This is because such bonds will move in value much more as the interest or inflation rate fluctuates.5

Some takeaways from the two graphs:

• Real return expectations from these minimal risk assets are currently near historic lows.

• Returns from these minimal risk assets have fluctuated quite a bit, because of changes in inflation and real interest rates, and can reasonably be expected to do so in the future.

• You can generally expect higher returns from investing in longer-dated bonds. If that matches your investment horizon, then hold your minimum risk bond portfolio through an ETF or index fund. But be prepared that particularly for longer-dated bonds, the yearly fluctuations in value can be significant.

Buying the minimal risk asset

Because of the costs involved in trading bonds, most investors in short-term bonds have to accept that in most cases the bonds in their portfolios will not be super short term6, and that you will be taking a little bit of interest rate risk as a result.

The most liquid short-term bond products like ETFs or index funds have average maturities of 1–3 years. The slight interest rate risk that comes from holding such bonds is a reasonable compromise between the theoretical minimal risk product and one we can actually buy in the real world.

For most investors with longer-term investment horizons, there are funds with different ranges of maturities like 5–7 years, 7–10 years, and so on, to suit your preferences.

How much of the minimal risk asset you should have in your portfolio and what maturities it should comprise depends on your circumstances and attitudes towards risk.

If you’re extremely risk averse, you might put your entire portfolio into short-term minimal risk assets, but you should not expect much in terms of returns. As you add more risk – mostly by adding equities – your potential returns will increase, and vice versa.

Varying the amount of minimal risk asset you hold in your portfolio adjusts the risk profile.

In the simplest scenario, where you only choose between the minimal risk asset and a broad equity portfolio, you could weigh the balance of those two according to the desired risk. The minimal risk bonds would have very little risk, whereas the equities would have the market risk. How much risk you want in your portfolio would be an allocation choice between the two (in a future post I will discuss adding corporate bonds).7

For some investors, putting 100% of their money in the minimal risk asset is their optimal portfolio. This would be appropriate if you are unwilling to take any risk whatsoever with your investments – and if you accept this means very low expected returns!

Summary

• If your base currency has government bonds of the highest credit quality (£, $, €) then those should be your choice as the minimal risk asset.

• If your base currency does not offer minimal risk alternatives, you have the choice of lower-rated domestic bonds where you take a credit risk, or higher-rated foreign ones where you take a currency risk. Keep in mind that any domestic default would probably happen at the same time as other problems in your portfolio, and your domestic currency would probably devalue. That would render foreign currency denominated bonds worth more in local currency terms.

• If you want the lowest risk you should buy short-term bonds. If you have a longer investment horizon, then match the maturity of your minimal risk bond portfolio with your time horizon. You will have to accept interest rate risk, even if you avoid inflation risk by buying inflation-linked bonds.

Video on your low risk portfolio allocation

Here’s a video that recaps some the things I’ve discussed in this article. You will also find other relevant videos on my YouTube channel.

Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating any to medical research. He also wrote Confessions of a Hedge Fund Manager.

1. Private investors may also want to consider cash as part or all of their minimal risk asset allocation. Please see my previous article for more details. This article will focus on the traditional minimal risk building block – high rated government bonds. [↩]
2. There are cases where the yield curve is reversed and shorter-term bonds yield more than longer-term ones, but these cases are less frequent. [↩]
3. Or cash. See the previous article on the minimal risk asset. [↩]
4. i.e. The purchasing power a year hence would still be $100 in today’s money even if the nominal amount had become $102. [↩]
5. The market view of credit worthiness will also have played a role. [↩]
6. Imagine the scenario where you want to hold one-month government bonds. Tomorrow the bonds are no longer one-month to maturity, but 29 days. Is this ok? How about 2 days hence? How much you are willing for the maturity to deviate from exactly 30 days is up to you, but in reality there is a trading and administrative cost associated with trading bonds. It would simply not be feasible to stay at exactly 30 days to maturity at all times. [↩]
7. Certain corporate bonds trade with lower risk premiums than many governments. The view is that these corporate bonds are lower credit risk than many governments – not hard to believe – and although they do not have the ability to print money, nor do governments in the eurozone. The reason I believe that you should not consider these bonds as the minimal risk asset is more practical. Compared to government bonds, the amount of corporate bonds outstanding for any one company is minuscule and you would probably not be able to trade them as cheaply and liquidly as government bonds. [↩]