Everlake Guide to Sustainable Investing

Introduction

As our client, we believe that you should have the opportunity to consider and engage with investing your wealth in a way that is sustainable for our collective futures

We say ‘consider’ because sustainable investing is a decision that tries to reflect one’s personal values, alongside seeking financial returns.

We say ‘engage with’ because sustainable investing differs from traditional investment approaches. It is a topic that needs to be examined and understood before you make your decision.

At Everlake we approach the topic of sustainable investing in an informed and impartial manner.

Our experience in the field of sustainable investing dates back to 1997, when one of our founding firms, Ethical Financial, was established Since then, our continued pursuit and research into this field has given us unique perspective and insight into the technical and emotive details of the subject.

We recognise that an individual’s values are personal to them, and we don’t seek to assume or ascribe a certain value set to our clients.

Sustainable investing is a core part of our investment offering. During our advisory process, we assess your attitude to sustainable investing as a routine part of our engagement process1 . We use our expertise and experience in this field to explore both the financial goals and personal values of our clients. This is very much a collaborative process, and the outcome will look different for each person.

Should you wish to invest sustainably, we can advise you on a range of appropriate investment portfolios. We will spend time with you examining your options and explaining the related risk, reward, and cost implications of investing in this way.

This guide is intended to set out a few key concepts of Sustainable Investing such as:

• What is Sustainable Investing?

• How is Sustainable Investing different?

• Does Sustainable Investing make a difference?

• Will it affect my returns and increase my costs?

• Is this the right option for me and should I consider it?

We would be delighted to meet with you to talk you through any of your queries or discuss your thoughts on this topic.

1 See Everlake Financial Planning – Our Approach for more detail on how we will work together

What is Sustainable Investing?

Sustainable Investing has become a strong social movement in recent years with volumes of investment expected to reach some $50 trillion in 2025, according to Bloomberg Intelligence.

Increased demands from investors for transparency and progress on sustainability issues has ensured that investment managers have to continually consider and report on issues that were not considered important factors just a generation ago.

Terminology

Firstly, it is important to define the term ‘sustainable’. We define the activity of being sustainable as improving the world through tackling major societal issues. This can take the form of addressing climate change, and its subsequent effects such as economic migration, to addressing income inequality and poverty.

The United Nations’ Sustainable Development Goals (SDGs) is a set of seventeen global goals that have been defined to support the world's transition to sustainable development and a sustainable future. The SDGs describe the greatest challenges and needs of our time and the actions for addressing these.

The SDGs are designed to fundamentally transform our economy, our society, our way of life, and the way we consider our environment through the use of new scientific and technological capacity and improved resource efficiency. They are a bold commitment to improve our World and tackle some of the more pressing challenges facing the world today2 .

All seventeen goals interconnect, meaning success in one will affect success for others. Dealing with the threat of climate change impacts how we manage our fragile natural resources; achieving gender equality or better health helps to eradicate poverty; and fostering peace and inclusive societies will reduce inequalities and help economies prosper. In short, these represent the greatest chance we have to improve life for future generations.

2 See https://sdgs.un.org/goals for more information:

Achieving these goals requires collective action across governments, civil society, the private sector, and dedicated individuals and communities to drive implementation.

At Everlake, we take our role in contributing towards the achievement of these goals very seriously. For this reason, we have routinely introduced the topic of sustainable investment to all of our clients over our years of operating.

There are currently multiple terms for ‘sustainable investing’ being used interchangeably which can be confusing for everybody Examples include ethical investing; Environmental, Social and Governance (ESG) investing; responsible investing; green investing; sustainable investing; and impact investing. This proliferation of terminology is not unusual for new, or relatively new fields of study – it usually takes time for a dominant descriptor to be adopted.

Our advice is not to get bogged down or side-tracked trying to define terminology. Many of the words are used interchangeably at this time, but more importantly point to an overall shift in investment circles. Values-based considerations are forming a significant factor in how people choose their investments.

We use the term Sustainable Investing as our preferred term for investing that:

• Focuses on long-term returns through consideration of pertinent ESG risks & opportunities

• Achieves sustainability outcomes (for example investing in renewable energy)

• Reflects a particular set of values or beliefs

Greenwashing

You may have come across the term ‘greenwashing’, a term that has become common in describing many large players in the fashion industry over the last five years. However, the term can be applied to any company or industry.

Greenwashing is the process of conveying a false impression or misleading information about how a company’s products are environmentally sound. In addition, greenwashing may occur when a company attempts to emphasise sustainable aspects of a product to overshadow the company’s involvement in environmentally damaging practices. We can offer due diligence, guidance, and expertise to our clients to identify greenwashing practices in potential investments

History of Sustainable Investing

Despite sustainability becoming a strong factor in investing decisions only recently, sustainable investing has a long history.

Faith-based communities have long influenced how their members spend and invest their money. Islamic banking, which is grounded in Sharia principles, dates to the beginning of Islam in the seventh century and prohibits investments in alcohol, gambling, and pork. In the west, Pennsylvanian Quakers had prohibited engaging in the slave trade by 1758. In his 18th century sermon, ‘The Use of Money’, John Wesley, one of Methodism’s founding fathers, mandated what type of company his adherents could and could not invest in, thereby providing us with an early form of negative screening.

These early roots helped coin the term ‘ethical investing’, as well as ‘sin-stocks’, ie the equities of companies involved in those prohibited areas like tobacco, alcohol, and gambling.

Over time, sustainable investing gradually moved from merely excluding certain stocks, to more complex positive screening strategies which aimed to support the environment and society.

In its simplest form, sustainable investing attempts to enact change in three main ways:

• Avoid/Exclude - investment funds actively seek to have a comprehensive exclusion criterion, setting threshold standards to avoid investment in socially or environmentally damaging products or unsustainable business practices. Typically, this will mean excluding weapon manufacturing companies, tobacco companies, or companies that have often been called ‘sinstocks’. More recently, this list has grown to include climate related stocks such as fossil fuels.

• Engage & Improve – where investment firms attempt to engage with Boards and company management to encourage companies to improve both their product and conduct. This involves a variety of strategies including actively engaging with companies via meetings, voting at AGMs, and ranking companies based on areas like their sustainable issues scores

• Positive Impact - investing in companies that provide sustainability solutions and/or companies that make a positive contribution to society and/or the environment. This particular strategy aims to reward companies that work on trying to make a direct positive impact on our world. For example, investing in water purification or renewable energy companies.

These strategies are all important in the field of sustainable investments and all are valid and interrelated. These strategies are key to our sustainable investment philosophy here at Everlake.

What is Driving the Move Towards Sustainable Investing?

As awareness of climate change grows, civil society is starting to change across the developed world. Climate activism has become a strong social movement in our society3. Science is no longer being ignored.

It is now universally accepted that the earth's temperature change has been on a significant upward curve for decades and is reaching irreversibly devastating levels as shown below. The leading scientific organisations in this field are consistent in their findings of this temperature rise.

Both the acceptance of science and the success of the climate movement has created a good foundation for governments to take regulatory action towards reducing carbon emissions. We have seen this with the Paris Agreement and the most recent COP agreements that are increasingly covered by the media.

In the field of investments, this social movement has also been a strong contributor in prompting governments and Central Banks to take measures to ensure that capital markets begin to make changes that positively reflect the future of our world.

Societal pressure and the movement towards a more sustainable focus has also created a momentum for Central Banks and governments to improve regulatory frameworks in the field of investing.

At Everlake, we welcome the increased regulatory focus on sustainable investing. Historically, sustainable investing has been somewhat a niche and small industry. Until recently, no regulation for classifying investments as sustainable or criteria to measure against existed

3 Climate activism: Non-Governmental Organisations (NGO’s) has been engaged in significant climate activism since the late 1980s and early 1990s as they sought to influence the United Nations Framework Convention on Climate Change (UNFCCC). Climate activism has become increasingly prominent over time gaining significant momentum during the 2009 Copenhagen Summit and particularly following the signing of the Paris Agreement in 2016.

In March 2021, a European regulation call the Sustainable Finance Disclosure Regulation (SFDR) was introduced

The regulation aims to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.

Since the SFDR came into force, asset managers have been required to self-classify funds sold in the EU as Article 6, 8, or 9. See Appendix 1 for more on this.

Regulation such as the SFDR ensures there is increased transparency in the industry and that claims of sustainability have to be proven.

In October 2022, one of the largest asset management firms in Europe, Amundi, downgraded $2 Billion worth of assets from Article 9 to Article 8 as they did not meet the enhanced requirements set by the SFDR.

We will discuss in more detail later what these Articles or ‘levels’ of sustainability mean, but the key point to note here is that these regulations are having a material difference. The investment industry is being forced to prove the level of sustainability within their funds.

How is Sustainable Investing Different?

Individual investors typically have a range of motivations and objectives when deploying their funds. These include financial, personal, and social considerations.

In tandem with this, investors need to consider the investment spectrum which spans the range of opportunities from investing where financial returns are the priority to investing where social outcomes are the goal.

The spectrum ranges from Agnostic (or conventional/market investing) which is focused on maximising financial terms, to Philanthropy which aims to maximise social outcomes.

See Appendix 2 for a short description of these terms and also our Guide to Investing in Ireland

Each of the various investment approaches has a particular attitude to risk and return and to its approach to Environmental, Social and Governance (ESG) considerations. There are potentially significant trade-offs among the distinct options.

Companies with good ESG scores tend to have common characteristics, distinct from the average company. In general, they tend to be younger, smaller with a growth orientation, and have what could be described as higher quality characteristics than the average company, e.g. the way they are run or their product sourcing. Quality in this sense does not necessarily equate to a better financial return. Generally, the risk and return characteristics also differ from the overall market. The extent to which they differ will depend on the particular characteristics of the investee companies. Sustainable funds with a high impact orientation may have a higher expected risk and potentially a related high expected return profile.

Sustainable investing with Everlake is not a ‘one size fits all’ approach. We recognise the importance of our client’s capital in providing for themselves and their families.

As outlined earlier, we use the term sustainable investing as our preferred term for investing that:

• Focuses on long-term returns through consideration of pertinent ESG risks & opportunities

• Achieves sustainability outcomes (for example investing in renewable energy)

• Reflects a particular set of values or preferences

Does Sustainable Investing Make a Difference?

We know that there is a trend towards investing sustainably but a key question is whether sustainable investing actually makes any difference towards the achievement of the UN SDGs. Given that the assets shift towards sustainable investing is only in the early stages, it is difficult at this point to measure the impact. However, there is no doubt that companies' behaviours are changing, as they seek to attract future investment from those with a preference towards sustainability There are a few key impacts we can point to already:

More Committed Shareholders

Sustainable investment funds are considered to have more committed shareholders. Their valuesbased commitment to their holdings positively impacts their holding period. This ensures that short term performance is no longer the only metric that shareholders are using to evaluate their holdings. A positive outcome for companies is that their funders are more ‘sticky’ through the ups and downs of market cycles. Sustainable Investors are therefore attractive investors to companies as they offer more long-term stability for the company.

Active Ownership & Engagement

In addition to being more committed shareholders, sustainable investment funds tend to engage directly with companies to achieve positive social change. Being part of an investment fund means being part of a larger collective voice. Government, customers, boards, management, and employees can collectively exercise significant influence on the sustainability of any company.

In seeking to invest sustainably, a fund manager can exercise their mandate by excluding certain companies from their funds, engaging with Boards and management to improve their sustainability performance, or investing in sustainability focused companies.

Recent examples of this include:

• In December 2022, the Norwegian Sovereign Wealth fund (which is approximately $1.3trn in size and owns circa 1.5% of every listed company) announced that it plans to vote against companies that fail to set a net zero emissions target, overpay their top leaders, or do not have sufficiently diverse boards.

• In March of 2022, 53% of Apple shareholders backed a motion for the company to undertake an independent assessment of its adverse impacts to civil rights. This motion was filed by firms involved in Sustainable Investing and, due to its campaign, received the backing of large investment firms such as Blackrock and Citigroup.

Shareholder action is therefore becoming an increasingly loud voice in the investing world and is becoming harder for companies to ignore.

As a result, many companies are now embracing lobby and interest groups as they view ongoing active dialogue as providing them with insights into investors’ expectations of corporate behaviour. Indeed, research by Dimson, Karakas and Li (2015) shows that successful engagement between companies and shareholders results in increased returns to shareholders.

Will it Affect my Returns & Increase my Costs?

At Everlake we believe investment returns are explained by the following investment decisions: asset allocation, diversification, size, stock characteristics, and investment approach.

1. Asset Allocation

Asset allocation is the process of deciding how much of your portfolio to invest in each of the different investment types, or asset classes. These asset classes are equities, bonds, and short-term investments, as well as ‘real assets’ like real estate or commodities. (See Appendix 5 ‘Modern Portfolio Theory’ in Our Guide to Investing in Ireland for more on this).

Asset allocation accounts for about 90% of investment performance. Therefore, we want our clients to understand with this aspect of investing.

The pie chart below illustrates a typical investment asset allocation.

Historically, when sustainable investing was in its infancy, funds only catered for one asset class - that of developed equities.

However, the more recent flows of money coming into Sustainable Investing, have provided for sustainable options in each of the asset classes outlined in the pie chart above.

An incredibly positive development and something which ensures Asset Allocation remains strong for our clients whilst they seek to have their funds invested in a sustainable manner.

2. Diversification

Diversification in your portfolio reduces stock specific risk. Modern Portfolio Theory outlines how it is primarily stock-specific events that cause individual stocks to move up or down wildly, relative to the overall market.

Stock-specific movements of individual stocks may not be predictable, but when considered over a diversified portfolio, they tend to cancel one another out. A diversified portfolio should expect to have some investments going down from time to time and some going up (if all are going in one direction, your portfolio is not diversified).

From a sustainable portfolio perspective there is a material difference between sustainable portfolios and traditional market portfolios. This is due to two factors: a) Concentration of stocks. Global stock markets have about 12,000 stocks from which an investor can choose. When we apply strict sustainable criteria to this number, the numbers can drop to as little as 400 to 500 stocks. This results in a higher degree of concentration of particular type of stocks in a sustainable portfolio compared with a traditional market portfolio. While Credit Suisse in their 2020 Investment Paper4 found that there is no evidence that this concentration leads to lower long-term outcomes, they do point to an increase in short term volatility. b) Profile of companies. Sustainable portfolios also differ from a traditional portfolio in terms of the type of companies contained within. Companies are generally classified by two main criteria: size - which is measured by share capitalisation; and growth - which is measured by their expected future earnings.

3. Size of Corporations

Stocks can be categorised by size.

• Large-cap corporations - the global names that we are all familiar with are large-cap stocks. These will typically comprise a substantial proportion of the global stock market. They are those with market capitalizations of US$10 billion+ and tend to be more mature companies, grow slower than smaller companies, but are also expected to be less volatile

• Mid-cap corporations - the next tier are mid-cap stocks, those with capitalisation between $2 and $10 billion. These tend to have more aggressive growth than large cap companies.

• Small-cap corporations – the smallest stocks are referred to as small-cap stocks. They have capitalisation between $300 million and $2 billion. These stocks are cheaper and more affordable for investors but are significantly more volatile than larger cap companies.

Each tier of stocks has a different risk and return profile. There is evidence that a portfolio of small stocks has a higher return over the longer term, but this is associated with higher volatility in the shorter term.

Sustainable Portfolios tend to prioritise stocks that are newer (medium and small cap).

4. Stock Characteristics

Sustainable investments often differ from traditional investments based on stock styles known as growth or value.

• Growth stocks tend to have a high score on metrics such as long-term projected earnings growth, historical earnings growth, sales growth, cash flow growth and book value growth. Typically, many of the well-known technology stocks would fall into this category Analysts consider growth stocks to have the potential to outperform either the overall markets or else a specific sub-segment of them for a period of time.

• Value stocks tend to be those stocks which have a lower score on a range of metrics like priceto-projected earnings, price-to-book, price-to-cash flow, and dividend yield. These are often more cyclical or out-of-favour businesses which from time to time will change as the fortunes of different industries ebb and flow. Value stocks will generally trade below what they are really worth and therefore have a higher expected return. They tend to be mature businesses that pay strong dividends to investors. An example of the Top 10 holdings in a Global Value Portfolio would be:

Source: dfa.com

Small, mid, and large-cap sectors can all contain growth stocks, but they can only remain in this category until analysts believe they have fulfilled their potential. Growth firms are forecast to outperform many of their rivals in their industry, either because they have a product or line of products that are likely to sell well or because they appear to be operated more efficiently than many of them. The key to growth stocks is their potential.

An example of a growth stock would be First Solar, a leading maker of solar panels which convert sunlight into electricity with no carbon emissions. Massive growth prospects for the renewable energy industry and consistent year on year growth for the company for the last number of years illustrates this stock’s growth characteristics with extremely high future price expectations.

The growth trajectory of this company would indicate it is in the initial stages of reaching its potential and as regulation and consumer values continue to move in favour of renewable energy, this type of stock should benefit and fulfil its projected potential.

To be clear we are not advocating for this stock but merely using it as an example of what is meant by a growth stock in sustainable investing. Growth stocks typically do not pay significant dividends to investors as they try to reinvest their profits into future growth of the company.

Sustainable Portfolios tend to prioritise stocks that are newer (medium and small cap) and more future growth focussed.

Sustainable Investors should know that their investment portfolio characteristics are significantly different than a traditional portfolio. We do not mean this is better or worse, but it is important to note that there are genuine differences.

5. Investment Approach & Impact on Cost

Investors can use different management strategies to generate a return on their investment accounts, described as ‘active’ or ‘passive’ portfolio management.

• Active portfolio management focuses on attempting to outperform the market in comparison to a specific benchmark such as the MSCI World Index, by using a stock selection or marketing timing strategy.

• Passive portfolio management mimics the investment holdings of a particular index in order to achieve comparable results as the index. There is no attempt at outperforming the benchmark, it is simply tracking the benchmark.

When sustainable impact is the focus, the funds chosen tend to be active managed funds. This active management style is the most significant factor in increasing the costs associated with sustainable investing.

Active managers in the sustainable field incur significantly more cost to operate as their processes involve a much deeper analysis of a particular stock, bond, or any asset.

A passive fund on the other hand can buy data and apply this data to which companies they invest in without having to employ more resources to screen and engage each company.

Active management costs on average 0.71%5 for an equity fund, compared to only 0.06% for the average passive equity fund.

The costs need consideration from investors as there is no evidence that additional fees will lead to additional performance. Therefore, sustainable investors may need to accept lower returns for their preferred investment style.

As covered earlier, the risk profile and sequence of returns may be different. The implications are that your performance from time to time will look different to the market.

5 https://www.ici.org/system/files/attachments/pdf/per27-03.pdf

Is This the Right Option for Me & Should I Consider it?

Our advice process begins during a discovery meeting with you. We will discuss your financial values and goals, as well as your key relationships, existing assets, other professional advisers, preferred process, and important interests.

Taking a long-term investment view, we help you set objectives for your portfolio that are appropriate to your willingness, ability and need to take risk, and the investment horizon(s) you identify.

Sustainable investing can allow you to align your investment choices with your personal preferences and values.

Our belief is that sustainable investing can make a positive difference to our collective future. By joining your capital with other likeminded investors, the ability to influence the behaviour of companies, in line with sustainable values, increases.

We see continued evidence, via the flows of capital towards sustainable investing, and in the increasing regulation that is building, that sustainable investing is not just a craze that will pass with time.

Companies will amend their approach and behaviour if they continue to face rising potential barriers to raising investment because of low sustainability scores. The example of the Norwegian Sovereign Wealth Fund being a more assertive shareholder and voting against all companies who do not have a net zero target is a significant sign that sustainable investing is a serious movement, intent on achieving serious outcomes.

However, a note of caution, we need to be realistic that sustainable investing alone will not achieve the UN Sustainable Development Goals. Collective action is needed across governments, civil society, the private sector, and dedicated individuals and communities to drive implementation. Sustainable investing will play a role as part of the social movement towards achieving these goals.

At Everlake sustainable investing is a core part of our investment offering. We will take the time to explain the sustainable investment options together with related risk, reward, and cost implications of investing in this way.

The Next Step…

The Everlake team of financial advisors is dedicated to achieving excellent outcomes for our clients. We operate at the frontier of innovation and embody a willingness to challenge the status-quo at every turn.

Our high ethical standards apply to every aspect of our relationship with you, and through our culture of continuous learning. Each member of our team is highly qualified and capable of delivering world class financial planning solutions to you.

Arrange a meeting with one of our advisors to discuss your retirement planning by emailing enquiries@everlake.ie or book a call directly through Calendly here.

We look forward to working with you.

The Everlake Team.