Environmental Investment
Strategies and Portfolio Construction
By
Victor Bivell
Eco Investor,
August 2008 Edition
The universe
of environmental investments on the Australian Securities Exchange (ASX)
is large enough to offer a workable range of choices for all the main
types of investors, be they income or growth focused, and conservative
or aggressive investors.
But environmental
investment is no different to any other type of investment - before moving
to portfolio construction, investors need to answer the same questions
about diversification, asset allocation, investment goals and risk tolerance
as they would for any equities portfolio.
The twist for
environmental investors is that they need to ask themselves whether they
want to add an environmental theme to their existing share portfolio,
or whether they want their entire portfolio to be environmentally friendly.
Their answer can help determine how they resolve the key issue of diversification.
Investors who
are drawn to the environment solely for its potentially high returns may
want to do no more than add an environmental theme to their existing portfolio.
These investors can simply bolt one on. Along with the target returns,
the environment can have the added benefit of increasing the diversification
of the existing portfolio, and where there happen to be some environmental
stocks already it may encourage them to better organize this part of their
portfolio.
It is not
nearly as straightforward for investors with a deeper commitment to the
environment and who want as much as possible of their portfolio to be
environmentally friendly. Such investors can still achieve a high level
of diversification, but it will not be as high as for general investors.
There is a
trade off between environmental commitment and diversification. Less diversification
is available for investors whose commitment precludes them from investing
in mining, oil, coal, uranium, high carbon energy generation, dangerous
chemicals, native forest destruction, ocean fishing, energy inefficient
properties, and other environmentally damaging activities.
For these investors,
it is particularly important to maximize the diversification within their
universe of suitable investments.
While some
investors will do their own due diligence on every stock, others may find
it easier to identify ethical and sustainability fund managers they are
comfortable with, and piggy-back on their stock analysis. They can do
this by investing in the managers' ethical or sustainability funds, or
using the funds' portfolios as stock selection guides.
For direct
investors, this approach will give them a suitable universe of stocks
for all the main themes on the ASX, such as banking, insurance, manufacturing,
resources, property trusts, infrastructure, healthcare, information technology,
telecommunications, media, transport, and so on. With this approach they
are moving to the greener end of each sector.
Australia has
a wide variety of ethical and sustainability funds so achieving diversification
should not be a problem.
As environmental
investors can be very committed to the theme, they should be mindful of
the importance all investment advisers and writers give to diversification.
Environmental commitment does not reduce the need for diversification
and should not diminish investment discipline.
With a diversification
strategy in place, investors can turn their mind to adding a specific
environmental theme to their portfolio. This can be done in at least two
ways.
Rather than
treat the environment as a separate theme, some investors may want to
operate within the existing ASX sectors that hold most of the environmental
stocks. At present the four main ones are energy, utilities, materials,
and industrials. They can do this by moving their stock selections to
the environmentally positive end of each index.
But the standard
way to add a theme is to give it an asset allocation. So what percentage
for an environmental investment theme - 5, 10, 20, 40 per cent? ? As there
are no rules, we are in the land of opinion, judgement and experience.
My own judgement
is that 5 to 10 per cent of an equities portfolio is reasonably conservative,
10 to 20 per cent shows a strong commitment but is still reasonably safe,
while above 20 per cent is on the aggressive side. As this is a personal
choice for each investor, others may differ.
Investors also
need to ask themselves what they want their environmental investment theme
to achieve? This is a rephrasing of the old question - do they want income,
capital growth, or a mixture of both?
Other key questions
asked by financial advisers at this point are: what is the investor's
time frame - short, medium or long-term; and what is their risk tolerance
- are they conservative, moderate, aggressive or speculative investors?
It is only by answering all of these questions that investors can sensibly
turn their mind to portfolio construction.
Eco Investor
Magazine has identified a universe of 26 "investment grade" Australian
environmental equities. By investment grade we mean they are either in
the ASX 300 Index, are interest rate securities, or can be classified
as emerging companies with profits and in some cases dividends.
The securities
can be grouped by whether they offer predominantly income (nine securities),
growth (seven securities), or both income and growth (10 securities).
The selection is based purely on environmental criteria. No attempt has
been made to apply a financial or investment quality screen. So they are
not investment recommendations, simply a listing of the universe of securities
for each investment strategy.
Speculative
Securities
The ASX has
well over 100 environmental micro caps. These are characterized by their
small capitalization and lack of assets, revenues, profits and dividends.
Their shares prices can also be quite volatile.
The junior
end of the resources sector has long attracted a following of speculative
investors, and the junior end of the environmental sector is similarly
open to speculation as it is large enough to offer a considerable range
of companies and technologies under development.
The above analysis
shows the ASX can support the development of an environmental investment
theme and offers a small but credible universe of investments for all
the basic investment strategies.
Investors
need add only the gamut of financial, industry, economic, geopolitical,
historical, charting, technological, management and other analyses, along
with the usual dollops of time and luck.
Victor Bivell
is editor of Eco Investor Magazine.
This article
was also published in The
Australian newspaper
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