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How to build a responsible investment portfolio

We explain how investors can build their own responsible investment portfolio.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Responsible investing has become more and more popular. The proportion of HL clients with at least one responsible investment fund in their portfolio has doubled over the past five years.

Building a portfolio with responsible funds isn't easy. 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.

We explain how investors can build their own responsible investment portfolio.

Ethics are personal, and responsible investment funds invest in a variety 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.

If you have a 5-10 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 10 years or more you can afford to take a little more risk and invest a bigger part of your portfolio in share based investments. Taking more risk could mean you see some potentially 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.

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 specific risks of a fund before they invest and make sure any new investment forms part of a diversified portfolio.

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

A balanced core

Global – wide ranging investments in global stock markets

We think a global tracker fund like the Legal & General Future World ESG Developed Index could act as part of the backbone for lots of responsible portfolios. It invests in over 1300 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 environmental, social and governance (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, makers of controversial weapons (like cluster munitions, anti-personnel mines and chemical and biological weapons) or persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption).

Find out more about Legal & General Future World ESG Developed Index, including charges

Legal & General Future World ESG Developed Index Key Investor Information

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 responsible investment fund focusing on the UK stock market.

The fund's been managed by Audrey Ryan for more than two decades. 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.

This fund holds shares in Hargreaves Lansdown plc.

Find out more about Aegon Ethical Equity, including charges

Aegon Ethical Equity Key Investor Information

Mixed – a mixed asset diversifier

BNY Mellon Sustainable Real Return could also be a good option as part of the core section of the 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.

Find out more about BNY Mellon Sustainable Real Return, including charges

BNY Mellon Sustainable Real Return Key Investor Information

Fixed income – what about bonds?

For investors who want to reduce risk further, it could be worth thinking about a bond fund. 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 is 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 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.

Find out more about Liontrust Sustainable Future Corporate Bond, including charges

Liontrust Sustainable Future Corporate Bond Key Investor Information

Find out more about Royal London Ethical Bond including charges

Royal London Ethical Bond Key Investor Information

Some satellite ideas

Global – actively investing in global stock markets

The Stewart Investors Worldwide Sustainability fund could be a reasonable option. 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 behind this fund 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 a day 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.

Find out more about Stewart Investors Worldwide Sustainability, including charges

Stewart Investors Worldwide Sustainability Key Investor Information

Find out more about WHEB Sustainability, including charges

WHEB Sustainability Key Investor Information

Asia and emerging markets – looking for great leadership

Investors who are prepared to take additional risk in the pursuit of greater long-term returns could consider investing a small amount of their portfolio in Asia and emerging markets.

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.

Find out more about FSSA Asia Focus, including charges

FSSA Asia Focus Key Investor Information

Find out more about Stewart Investors Indian Subcontinent Sustainability, including charges

Stewart Investors Indian Subcontinent Sustainability Key Investor Information

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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