How to build a responsible investment portfolio

Responsible investing is becoming more popular. The proportion of HL clients with at least one responsible investment fund in their portfolio has risen from 1.9% five years ago to almost 11% today.

It can be tricky building a responsible investment portfolio. It takes time to understand the approach each fund manager is taking, whether the fund has the potential to perform well over the long term and how it fits into your portfolio.

Ethics are personal, and responsible investment funds invest in lots of different ways. It's important to check each fund is managed in a way that fits with your values before you invest.

The basics of building a portfolio

Before you start investing, we think it's important to consider your goals. You might want to build a lump sum for retirement, or help fund your children's education. Maybe you want to save for a wedding or a house. Remember though, investing is for the long term – that’s at least five years.

If you have a five to ten year investment horizon you should generally consider taking less risk, investing more of your portfolio in bonds or mixed asset funds.

If you're investing for ten years or more, you might want to think about taking a little more risk and invest a bigger part of your portfolio in share-based investments. Taking more risk could mean you see some big swings in the value of your investments, so make sure you’re comfortable.

When it comes to building the portfolio itself, we think a core-satellite approach is an option for most investors. The core usually forms the bulk of the portfolio, and is complemented by smaller 'satellite' investments, possibly in higher-risk areas.

The idea is to help you achieve greater returns with a relatively-lower level of risk, thanks to diversification. Holding a well thought out portfolio that invests in lots of different countries, industries and types of investment should reduce the impact of any one area performing poorly.

The value of investments, including lower risk investments, go up and down so you can get back less than you invest.

This article is for your interest only and is not personal advice or a recommendation to invest. If you need help building your own portfolio, or if you're not sure an investment is right for you, ask for financial advice.

The funds below are ideas to help build a portfolio – they shouldn’t be looked at as a model portfolio. Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own and there’s a specific need for the type of investment being made. Investors should understand the risks of each fund before they invest and make sure any new investment forms part of a diversified portfolio.

Ideas to help build a core

Global – wide ranging investments in global stock markets

We think a global ESG (environmental, social and governance) tracker fund could act as part of the backbone for lots of responsible portfolios.

The Legal & General Future World ESG Developed Index invests in almost 1400 companies across the globe and aims to track the Solactive L&G ESG Developed Markets Index.

The index increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions, to the number of women on the board and the quality of disclosure on executive pay. It also reduces weighting to companies that score poorly on these measures.

The fund won't invest in tobacco companies, pure coal producers or makers of controversial weapons (like cluster munitions, anti-personnel mines and chemical and biological weapons). It also won’t invest in persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption).

Please note the fund has the flexibility to use derivatives which, if used, adds risk.

FIND OUT MORE ABOUT LEGAL & GENERAL FUTURE WORLD ESG DEVELOPED INDEX, INCLUDING CHARGES

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UK – no place like home

As UK investors, we think it generally makes sense to pay extra attention to our home market. When we spend in sterling, we should usually hold some investments in sterling too. That way we don’t have to worry about changes in exchange rates.

We think Aegon Ethical Equity is a good option for a responsible investment fund focusing on the UK stock market.

The fund's been managed by Audrey Ryan for more than 20 years. She uses a strict approach and won’t invest in companies some might deem unethical – from tobacco and alcohol producers, to munitions manufacturers and companies that use animal testing.

The manager aims to identify and understand the key environmental, social and governance risks of each company, industry and sector she invests in. She believes companies that lead the way in governance and sustainability tend to outperform over the long run.

More than two thirds of the UK’s largest companies are excluded from the fund's investment universe for ethical reasons. This means there’s a focus on higher-risk small and medium-sized companies. The fund also holds shares in Hargreaves Lansdown plc.

FIND OUT MORE ABOUT AEGON ETHICAL EQUITY, INCLUDING CHARGES

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Options for income

The UK has also been a world-renowned income market – a UK-focused responsible income fund could be a good option to help add income to a portfolio.

The Janus Henderson UK Responsible Income fund aims to give a good level of income, alongside capital growth over the long term. Andrew Jones has been at the helm since January 2012 and has over 20 years’ experience managing UK equity income funds.

The fund won’t invest in areas that have a significant negative impact on people, the environment or animals. All investments must also be compliant with the UN Global Compact (a United Nations pact on human rights, labour, the environment and anti-corruption). Before adding any company to the fund, Jones carries out detailed ESG analysis, engaging with company managers if he feels there’s room for improvement. The manager’s flexibility to invest in smaller companies adds risk. Please note the fund takes charges from capital which could boost the income but reduces the potential for capital growth.

The Trojan Ethical Income fund is a more conservative option for income. It’s managed by Hugo Ure, who leverages the skills and expertise of Troy’s highly regarded Equity Income team. The team aims to shelter investors’ money from the worst stock market falls, while increasing its value and paying a rising income over the long term.

The manager won’t invest in companies deemed unethical, including those with significant involvement in armaments, tobacco, pornography, fossil fuels, alcohol, gambling and high interest lending. He also carries out ESG analysis on each company to get a deeper understanding of the risks. Where he feels improvements can be made, he’ll engage with the company.

The manager’s flexibility to invest in smaller companies and derivatives adds risk. The fund also invests in Hargreaves Lansdown plc. Please note the fund takes charges from capital which could boost the income but reduces the potential for capital growth.

FIND OUT MORE ABOUT JANUS HENDERSON UK RESPONSIBLE INCOME, INCLUDING CHARGES

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FIND OUT MORE ABOUT TROJAN ETHICAL INCOME, INCLUDING CHARGES

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Mixed – a mixed asset diversifier

BNY Mellon Sustainable Real Return could also be a good option as part of the core section of a portfolio. It's more conservative in its approach, so adding this fund to the mix could help reduce risk.

Launched in April 2018, the fund follows the same robust investment process implemented by the same team as the BNY Mellon Real Return Fund, which has been on the Wealth Shortlist (and formerly the Wealth 50 and 150) since December 2010.

The team aims to make money in a variety of market conditions. The fund's 'return-seeking core' invests mainly in the shares and bonds of well-run, financially secure companies. They think these companies have a unique set of advantages over their competitors. They also consider how well those companies manage their impact on the environment and society.

The rest of the portfolio is invested in government bonds, commodities and cash, with the aim to dampen market ups and downs. The managers also have the flexibility to invest in emerging markets, high-yield bonds and derivatives which, if used, adds risk.

The fund's sustainable 'red lines' make sure companies that violate the UN Global Compact Principles and those incompatible with the aim of limiting global warming to 2°C aren’t considered. It also won't invest in any company that makes more than 10% of its revenues from tobacco.

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Fixed income – what about bonds?

Bonds are generally less volatile than shares – that means they normally don’t have as many ups and downs – so they can help with diversification. They also tend to grow more steadily over the long term. Remember it’s still possible to get back less than you invest.

We think the Liontrust Sustainable Future Corporate Bond fund could be a reasonable option for investing in corporate bonds. Managers Stuart Steven, Kenny Watson and Aitken Ross form a view on the outlook of the economy and then invest in bonds issued by companies that can hopefully thrive in that environment.

The managers believe companies whose products benefit the environment and society, and that manage their own impacts well, have the potential to do well over the long term. Their flexibility to invest in derivatives and high yield bonds adds risk.

Another option for investing in corporate bonds could be Royal London Ethical Bond, run by the experienced Eric Holt and his team. One of Royal London’s strengths is their bond analysis – they’re willing to do the work and analyse bonds issued by companies which haven’t paid ratings agencies to give them a credit rating. This gives them access to opportunities most others ignore, although it’s a higher-risk approach. The fund’s investments in high-yield bonds also add risk.

The fund has a broad policy of not investing in bonds issued by companies that generate more than 10% of their turnover from alcohol, armaments, gambling, tobacco or pornography. They also avoid companies with inappropriate or inadequate policies around animal testing, human rights and the environment. The screening process also identifies companies that have the opportunity to make a positive impact.

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FIND OUT MORE ABOUT ROYAL LONDON ETHICAL BOND INCLUDING CHARGES

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Some satellite ideas

Global – actively investing in global stock markets

The Stewart Investors Worldwide Sustainability fund could be a good option to add a satellite to the mix. Manager Nick Edgerton invests in companies of all sizes, including higher-risk smaller ones. The emphasis is on companies that have a positive impact on society, the environment and health.

The manager's sustainable approach means he’s unlikely to invest in certain areas like tobacco, alcohol, and weapons, but they’re not specifically excluded. Investors should note the fund has investments in emerging markets and is a concentrated portfolio. Both of these factors increase risk.

Some investors want to feel they're making a positive difference to the environment and society through their investments. Impact funds measure and report back on the positive impact they set out to make on the environment and society.

We think WHEB Sustainability could be a sensible option. The team invest based on nine sustainable investment themes. These range from resource efficiency and sustainable transport to education and wellbeing. The fund invests in emerging markets which can increase risk.

Every investment into the fund makes a positive difference. £10,000 invested into the fund in 2019 helped:

• Generate 8 MWh of renewable energy
• Avoid 9 tons of carbon dioxide emissions
• Treat 110,000 litres of waste water for reuse
• Recycle or recover 2 tons of waste material
• Provide two days of tertiary education
• Two people receive healthcare treatment, and saved £490 of costs through more efficient healthcare systems

This is the only fund managed by the WHEB team, meaning they're solely focused on it. However, the portfolio looks very different to the broader global stock market, so we expect it to perform differently too. The fund's focus towards small and medium-sized companies adds risk.

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Asia and emerging markets – looking for great leadership

Asia & emerging markets offer the potential for greater long-term returns, but they’re riskier than developed ones. So investments here should usually form just a small part of a well-diversified portfolio.

The FSSA Asia Focus fund is managed by Martin Lau and his team who we hold in high regard. They have a wealth of experience investing in the Asia Pacific region, including higher-risk emerging markets. They look for companies with strong cash flows, an ability to keep costs under control and high standards of company management.

The team’s investment philosophy is founded on stewardship. When they make an investment, they see themselves as part owners of the business. So they engage with companies to make sure they’re run in a way that’ll benefit all shareholders, and also consider environmental, labour and other governance issues.

The Stewart Investors Indian Subcontinent Sustainability fund focuses more on India and Bangladesh, which are higher-risk emerging markets. Managers Sashi Reddy and David Gait invest in companies they believe could benefit from and contribute to the sustainable development of the countries they’re based in.

Analysing environmental, social and governance information helps them understand more about the quality of companies. They think their long-term investment horizon makes sustainability even more important. The fund's investments in smaller companies add risk.

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