On October 3, 2023, Sam had the opportunity to represent Advantage Capital Strategies Group on a panel at the University of Toronto and Massey College 60th anniversary conference on Sustainability.   The focus of the conference was on a further 60 years of prosperity and it brought together government, academic and business leaders across a range of different sessions.  Sam spoke on Sustainable Finance and ESG investing. He was joined by Pete Richardson, head of Research at Manifest Climate, Toby Heaps, the CEO of Corporate Knights and Susan McGeachie, a Professor at the School of Environment at the University of Toronto.  Following the Question and Answer format from the event, here are some of the thoughts that we discussed:

What is the future of Sustainable Investing?

There is not a one size fits all approach to investing, or sustainable investing.  Some investors want to achieve social goals, whereas others have certain industries that they want to eliminate.  For sustainable investing to become more mainstream and appeal to a wider audience, there should be strong financial return, as well as accomplishment of social and environmental outcomes.

How can we foster a green economy?

Companies and organizations are often faced with business decisions that will either serve to reduce or increase their carbon footprints.  The very same decision may also increase or decrease that company’s expected profit/expense.  When something both reduces the carbon footprint and increases a company’s profit, it becomes a no-brainer decision.  For example, replacing a buildings light bulbs to LED lights, saves on electricity and has a very quick payback period.

The role of innovators, be it government, not for profit or the business and investment community, is to help move technologies into the no brainer category, where they can both reduce carbon and create profit.

What is the role of data in Sustainable Investing?

Data needs to be high quality for it to be useful for us.  Therefore, data is most effective when there is replicable measurement and reporting, and thus investors can rely on it to make decisions. 

Much of the data in the finance world is qualitative, and collecting this data at a high level of quality is difficult.

What role can University of Toronto play in a Sustainable economy?

Academic institutions have the ability to convene practitioners in all fields and all sectors.  They can also focus on practical and applied research.  By using this convening power and information from applied research, they can positively influence decision makers in all sectors to build towards sustainable futures.

As a follow up, they can foster innovation at the individual level.  One of the most impactful things we do at ACS is hire a summer student from a University who is not necessarily in the finance field.  We ask the student to get deeply informed about a Sustainable investing area that is important to them and teach us about it.  Past students have helped turn our attention to the waste created by fast fashion and the human rights violations towards the Uyghur Muslim population.  

Executive Summary

Passive investing is a broad and growing area of finance, and an important part of our work at ACS Group.  Our approach puts a sustainable investment lens on passive investment strategy.  We omit the most negative industries for the planet and society, while taking larger positions in all the rest.  Our thesis is to create financial outperformance by avoiding these negative industries, while also overweighting industries that are creating more positive impact for society and the planet.

1) What is Passive Investing?

Passive investing is a long-term investment approach that sets investment decision making rules in advance of making an investment. The portfolio manager then follows those rules, regardless of day-to-day fluctuations in the markets. This stands in stark contrast to active management, where the primary purpose is to identify securities that will outperform a benchmark.

2.1) Advantages of Passive Investing

2.2) Disadvantages of Passive Investing

3) Passive vs. Active: Which Strategy Outperforms?

It is not straightforward to determine whether passive or active investing outperforms.  However, there are some data points, which indicate that passive investing tends to outperform active investing over a longer time horizon.  This is driven partly by the lower cost and tax efficiency of passive investment, coupled with active managers’ inability to effectively time the market over long periods of time.

4) The ACS Approach to Passive Investing

At ACS Group, we exclude companies that operate in industries we think will financially underperform, while taking larger positions in all the rest.  We look to avoid the most negative industries for the planet and society.  These include fossil fuels, weapons, tobacco, alcohol, and predatory lending.  

It is not always straightforward to determine in which industry a company operates, and for that reason, we conduct our own proprietary research into company fundamentals.  We also leverage industry specific research sources and aren’t tied to industry classification schemes, unlike third party research providers.  Above all, we make our screening and industry research program central to our investment thesis, and resource it fully.

ACS Group Perspective: Passive Investing Primer

At ACS Group, a large part of our investment strategy involves passive investment, using a sustainable investing lens.  Our approach to passive investment is to avoid industries and companies that we think have a strong likelihood of financial underperformance due to having the most negative impact on society and the planet.  We own more of all the remaining companies in the index, as we think this will create the strongest return profile, while creating a more positive impact on the planet and society. 

This primer will outline 1) What is Passive Investing; 2) The Advantages/Disadvantages of Passive Investing; 3) Passive Vs. Active from a performance standpoint; and 4) The ACS Approach to Passive Investment

1) What is Passive Investing?

Passive investing is a long-term investment approach that sets investment decision making rules in advance of making an investment. The portfolio manager then follows those rules, regardless of day-to-day fluctuations in the markets.  Passive investing does not attempt to identify mispriced individual securities.  This stands in stark contrast to active management, where the primary purpose is to identify securities that will outperform a benchmark.

The typical characteristics of a passive strategy are:

2) Advantages and Disadvantage of Passive Investing

2.1) Advantages of Passive Investing

Lower Cost, Lower Turnover and Higher Tax Efficiency Means More Money Invested: The lower cost and lower turnover nature of passive investing is conducive to better after-tax returns for investors.

Focus is on “Time in the Market”, not “Timing the Market”: By setting the rules in advance, passive investing eliminates the temptation to “time the market” by seeking mispriced individual securities.  By avoiding this temptation, the investor avoids decision paralysis which causes investors to delay making investments and potentially miss out on returns.

Fully Invested in all Major Companies: By owning all the components of an index, the investor has exposure to every company and industry that makes up the public market.  As such, the investor is more likely to capitalize when certain industries or companies perform well.  For example, for the first half of 2023, the top 10 performing companies in the S&P 500 accounted for approximately 72% of the S&P 500 return.  Being underinvested in any of these companies would put an investor or fund manager at a significant disadvantage.

Higher Likelihood of Capturing Market Returns than Active: The focus of passive investment is on capturing market returns, or beta.  Doing so can be accomplished in a relatively systematic process.  This contrasts with active strategies which seek outperformance, at the risk of underperformance.   

2.2) Disadvantages of Passive Investing

Top Heavy Holdings: The most popular passive approach, market cap weighted index strategies, lead to a high weighting in the largest companies and a negligible weighting in smaller companies.  For example, imagine a 20% increase in the stock of a company that makes up 10% of the index.  This would result in a 2% gain.  Now, imagine the same 20% increase for a stock that makes up 0.1% of the index.  This will result in a 0.02% increase for the index.  More than 250 of the companies in the S&P 500 have a weight of 0.1% or less of the index.  In contrast the top 10 holdings account for approximately 30% of the S&P 500 index.

Inability to Focus on the Short Term: As the investment rules are set in advance, a passive manager cannot typically make tactical decisions based on short term factors.  In some cases, these short-term decisions end up being correct and the active fund will benefit. 

Poorer Access to Non-Traditional Markets: It can be harder for passive managers to create indexes in frontier and non-equity markets.  Liquidity and transparency in these markets are lower, which does not suit a passive strategy.

Lower Likelihood of Outperformance: As the majority of passive investing focuses on replicating market returns, there is a lower likelihood of market outperformance.

3) Passive vs. Active: Which Strategy Outperforms?

Determining whether active or passive managers historically outperform the other seems relatively straightforward, but in practice is a complicated exercise in data analysis.  There are some data points, however, which indicate that passive investing tends to outperform active investing, particularly over the past 15 years.

All that said, there are active funds that have outperformed.  In particular, certain investment styles, such as value or growth, or investment themes, such as energy transition or biotechnology, have all had time periods where they have performed better than their passive peers.  This can be because the fund has chosen industries that have outperformed, and also that the active fund has avoided industries that underperform, such as when the tech bubble burst in 2000.[6]  There is a school of thought that active investors do better in years when there is greater dispersion among the stocks and industries in an index, allowing them to pick outperformers.  The key for active investors is to make the correct decision when to rotate into various styles, themes, and industries, which can be challenging to accomplish consistently.

4) At ACS, we approach Passive Investing using a Sustainable Investing Lens

When we set out to build ACS, we determined that the passive investing landscape was undifferentiated and did not allow investors to avoid the worst industries for society and the planet.  We think these worst industries will underperform financially, as the economy shifts away from fossil fuels and activities that are overtly harmful to human health.  As such, we designed an approach that omits fossil fuels, weapons, tobacco, alcohol and a few other negative industries from our holdings.  We call these our screened industries.[7]

We use Solactive indices as our starting point, as they provide rigorous index construction methodologies at a low fee, which lowers the cost to our investors.  We then go through each company in the index, and using a revenue threshold as our guiding point, determine its involvement in our screened industries.  We have set thresholds depending on the industry. 

For example, we have a near zero-tolerance policy with weapons, so any company that derives more than 5% of its revenue from weapons will be screened out of our portfolio. If it derives between 0% and 5% of its revenue from weapons, we consider this the “gray area”.  We then look at the particulars of that company and make a judgement call.  We will consider revenue trendlines, such as whether the weapons business is expanding or contracting, intention to divest, among other factors. 

On the more lenient side of the spectrum, an example is the engineering and construction industry which often has exposure to oil and gas.  As they are not directly involved in the production of fossil fuels, we use a higher revenue threshold level.  Above 50% from oil and gas will result in divestment.  From 25% to 50% revenue, we consider this the gray area, where we make a judgement call.

Admittedly, there is no exact science in determining what to exclude and what to include and the related revenue thresholds.  We have made a judgement call based on how harmful activities are to people and the planet.  We also consider the ability of the industry to make a transition away from said harmful activity.  For example, weapons have the purpose of killing people, so in our view, this is as harmful as it gets, so we are quite strict.  On the other end of the spectrum, an oil and gas consultancy that has other business lines can reduce its exposure to work from the fossil fuel industries as our economy transitions away from fossil fuels. 

What makes our approach unique is several factors:

[1] CFA Institute, Passive Equity Investing, https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/passive-equity-investing

[2] Morningstar, Active Vs. Passive Barometer, https://www.morningstar.com/lp/active-passive-barometer

[3] S&P Global, SPIVA, https://www.spglobal.com/spdji/en/research-insights/spiva/#europe

[4] PWL Capital, The Passive Vs. Active Fund Monitor (2022), https://www.pwlcapital.com/resources/the-passive-vs-active-fund-monitor-2022/

[5] Ibid

[6] Hartford Funds, the Cyclical Nature of Active and Passive Investing, https://www.hartfordfunds.com/insights/market-perspectives/equity/cyclical-nature-active-passive-investing.html

[7] We screen for fossil fuels, gambling, weapons, tobacco, alcohol, predatory lending and severely controversial business practices (e.g. history of fraud, worker abuses, etc.).

[8] Morningstar, Active Vs. Passive Barometer, https://www.morningstar.com/lp/active-passive-barometer

[9] Edison Institute, Industry Data, https://www.eei.org/en/resources-and-media/industry-data

What is Socially-Responsible Investing?

Socially-responsible investing (SRI), or sustainable investing, is a broad term used by many investment firms and applied with various nuances.  SRI commonly refers to the practice of excluding from a financial portfolio those companies that are involved in industries affected by negative environmental, social, or governance (ESG) issues.  However, as outlined in the Harvard Business Review (2019), there are many strategies for sustainable investing:

As part of active ownership some SRI firms may also practice shareholder engagement, meaning that they vote in or file shareholder resolutions proposing changes in the way a company operates. Shareholder resolutions can help bring more transparency to a company, demand increased gender diversity on a board, or even pressure a company to begin ESG reporting.  Some examples of successful shareholder resolutions addressing ESG issues can be found here: www.ussif.org/resolutions.

A central premise of SRI is that companies that exhibit negative environmental, social, and governance factors pose both a financial risk as well as a risk to local and global wellbeing.  Ultimately, the industries or companies that an SRI firm decides to exclude vary depending on the firm. 

SRI at Advantage Capital Strategies Group

At Advantage Capital Strategies Group, our approach to SRI refers to the exclusion of companies involved in any of the following industries:

SRI in Canada

Socially-responsible investing is experiencing profound growth both in Canada and worldwide.  The value of Canadian assets deemed to be responsible investments is estimated to be over $2.1 trillion and growing.  In fact, according to the Responsible Investment Association, responsible investments now account for over half of all Canadian assets under management.

Many investment firms offer socially-responsible products or strategies, but only some apply socially-responsible principles to their entire investment portfolio.  Advantage Capital Strategies Group is focused primarily on responsible investing and economic return; these principles are inextricable from our identity, and we believe that they are not mutually exclusive.  In fact, research demonstrates that investments made using SRI principles are lower in risk and outperform traditional funds over 60% of the time.

The SRI Landscape

Globally, SRI continues to grow and capture the attention – and assets – of investors.  In Europe SRI funds hold at least half of all assets, while in the United States investors have been slower to adopt ESG principles, with the Harvard Business Review estimating that about 25% of American assets are in SRI funds.  According to the Responsible Investment Association and the Harvard Business Review, 50% of Canadian assets are in SRI funds, a level similar to Europe. Globally, it is believed that over half of all assets are either already in funds that consider ESG factors or funds that are in the process of evaluating ESG factors. Considering that SRI is still a growing field, it is not difficult to imagine a future in which most assets are held by funds that utilize sustainable investing strategies. 

SRI is practiced by many types of investors, ranging from individuals to pension plan administrators to religious institutions.  Different types of investors may have different reasons for choosing SRI: for some, social activism may be the most important factor, while others may use SRI as a means of limiting asset exposure to companies at risk of being affected by climate change or other ESG factors.

Trends in SRI

Standardized SRI reporting

Unlike financial reporting, which is regulated federally, there is no regulated or standardized method of reporting ESG performance.  Therefore, if a company includes an ESG report in its Annual Report, they do so of their own accord and often according to their own standards.  Some companies report ESG performance using the standards developed by the Sustainability Accounting Standards Board (SASB), an independent organization offering standardized methodology for ESG reporting, but other companies may not report ESG performance at all. 

There are many ways that SRI will grow and change in the future, but one change that researchers anticipate is that ESG performance reporting will become regulated and standardized just like financial reporting.  Such a change would allow for more accurate comparison of ESG performance between companies.

Private company impact investments

There is an increasing view that SRI can fall across asset classes.  Notably, private company investments might be the most conducive to impact investment, as investors have more flexibility in accessing management and setting company direction.  As such, investments can be made with the understanding that the creation of social impact, as well as financial returns are one of the driving factors in company success.

Fiduciary duty

Another change that may arise is in the widening of the definition of fiduciary duty to include consideration of ESG factors. Fiduciary duty refers to the legal obligation of one party to act in the best interest of another party, such as in the advisor-investor relationship, where the advisor is bound to act in the best interest – financially – of the investor.  However, because ESG factors have been demonstrated to influence financial performance, it is possible that the legal definition of fiduciary duty may widen to include necessary consideration of ESG issues.  Implemented on a national or global level, such a shift would effectively make ESG-based investing the standard for investment practices.  There is already some evidence of such a widening occurring: for example, in Ontario, the Financial Services Commission has issued a note requiring pension plan administrators to disclose their approach to considering ESG factors when developing the plan’s investment strategy.

The level of discussion concerning the relationship between fiduciary duty and ESG factors suggests indicates the growing prevalence of SRI at the national and international levels.  There is still more research and growth needed in the field of sustainable investing, and many organizations and institutions are working to fill these gaps.  Advantage Capital Strategies Group is proud to be part of the growing community of sustainable investors working to combine financial return with social responsibility.

For further reading, please visit:

Works Cited

Harvard Business Review Podcast: hbr.org/ideacast/2019/05/why-its-time-to-finally-worry-about-esg?referral=03759&cm_vc=rr_item_page.bottom

Harvard Business Review: hbr.org/2019/05/the-investor-revolution

Financial Services Commission of Ontario: www.fsco.gov.on.ca/en/pensions/policies/active/Documents/IGN-004.pdf

Responsible Investment Association: www.riacanada.ca/responsible-investment/

Responsible Investment Association: www.riacanada.ca/responsible-investment/#benefits-of-ri