We support the idea of aligning your finances with your values.  For many of our clients, one of their values is caring for the environment – our natural home which provides the water, air, energy, nutrients and beauty that make life livable.  The label we use to describe such values is “sustainability.”  This page describes the philosophy, strategy and tactics we utilize to apply sustainability criteria to investing, and thus align investments with environmental values.

Our Philosophy Towards Sustainable Investing

The first consideration is to make an investment portfolio strong.  To do so, we adhere to core investment principles such as, 

• Markets work efficiently
• Diversification mitigates risk
• Managing costs (keeping them low) is essential
• Your investments should be personalized for you

For more about our core investment philosophy and strategies, please refer to our general “Investment Management” page.

Our Strategy towards Sustainable Investing

There are two possible approaches to incorporating sustainable values into an investing strategy: 

1. Selective investment.  Start with nothing.  Pick and choose individual investments based on some sustainability scoring.
2. Selective de-investment. Start with everything.  Screen out individual investments based on some sustainability criteria. 

We chose option #2, selective de-investment.  The reason is that such a strategy stays true to our core principles of diversification and low fees.

You could think of the strategy as similar to sifting sand.  The possible investments are sand, and the screening criteria are like the sifter.  The sand gets poured through the sifter, which removes or reduces ownership of investments that cannot pass through.  Selective de-investing through a sustainability screen is a cost-effective way to construct a diversified investment portfolio.  

Image by John Chesbrough

Our Tactics for sustainable investing

The key to the strategy is the sustainable screen – how is it created?  what is it based on?  

The Sustainability Screen

The screen we use is a rules-based, data-driven, screening criteria.  It was created and is maintained by Dimensional Fund Advisors, or DFA.  DFA is the partner we work with to implement a sustainable investment strategy with our client portfolios (and our own).  At the bottom of this page is a link where you can learn more about DFA directly from them.  The following image presents a summary of the screening criteria for DFA sustainability investment funds:

Image courtesy of Dimensional Fund Advisors

Discussion of the Sustainability Screen

Layer #1:  Carbon (Equivalent) Emissions (85% weighting).    The primary screen is based on current and future carbon emissions because carbon emissions (or greenhouse gasses more generally) are the primary driver associated with Climate Change.  If you would like to read more about Climate Change, and the threat posed to the environment, there are links in the endnotes.  

The carbon emission criteria is calculated as a rate:  CO₂ emissions divided by revenues.  This criterion creates a “pollution efficiency” rating for each possible investment.  More specifically, the numerator is “CO₂ Equivalents” measured in millions of tons of emissions.  The word equivalent is used because the measurement includes six different greenhouse gas emissions including carbon dioxide, methane, nitrous oxide, and others.  The denominator is millions of dollars of revenues associated with the entity behind the investment (whether a stock or a bond).  

Layer #2:  Other environmental criteria (15% weighting).  The other 15% of weighting factors is a group of other issues such as land use, biodiversity impacts, toxic spills and water usage.  The full list is in the image above (central column). 

Layer #3:  Issue-specific layer.  Finally, the sustainability advisory committee at DFA identifies certain specific issues/industries to be specifically excluded from investment.  For example, the committee identified the palm oil industry as particularly problematic from a sustainability point of view.  The reason is that the large-scale manufacturing of palm oil is closely associated with the destruction of tropical rainforests.  For more information about palm oil, and its impacts you can go to the World Wildlife Foundation’s page on palm oil (see endnotes).  As of June 2023, companies that derive a majority of their revenue from the Palm Oil industry are excluded from the portfolio.  However, the industry may be changing practices.  If the industry, or particular companies within the industry were to change practices to be less impactful, this particular de-investment criteria may be removed or dialed back.

How the screen is applied

Once the screening criteria is applied to every investment, then the list of possible investments can be sorted from a large score (least sustainable) to small scores (more sustainable).  The investments with a large score are either excluded from the portfolio is reduced in ownership.   

Why do we like this particular screening criteria?

We like this criteria because it is:

a)  Reasonably objective (based on data vs. opinion or perception)

b)  Based on measurable data

c)  Cost-effective to implement

Who decides on the screening criteria?

DFA has an ESG (Environment, Social and Governance) Steering Committee made up of academics and DFA staff who use information from scientific research and survey data from advisors and clients to establish the sustainability screening criteria.  

Is the data good?

Since the screening criteria are based on data, a good question is “how reliable is the data?”  The short answer, is “the data is good, getting better, and never perfect.”  This is typically the answer to any data set.  It should be good (otherwise there is nothing to stand on).  It should be getting better through examination of fidelity and refinement of collection methodologies.  It is never perfect, meaning that the work of improvement is never finished.  

At the annual sustainability conference I attend, there are typically presentations delivered by independent experts (usually academics), who speak about the quality of the data.  My summary?  It is complex to measure carbon emissions.  There is a lot of attention and effort put into data quality.  There are ongoing efforts to improve the data quality.  That is the best we can ever expect from science.  The data is never perfect, but there should be ongoing efforts to “get it better.”  Those efforts are happening.  Since DFA is a data-driven organization, they make use of the bast-available data AND continue to explore the issue of data validity. 

What is the Impact?

Since DFA establishes a screen based on data and measurables, they can also measure and report on outcomes.  In terms of the biggest weighting (CO₂ equivalence emissions), the methodology has a strong outcome.  As of December 31, 2022, the portfolio was associated with a 77% reduction in carbon intensity of current emissions, and a 100% reduction in future emissions.

Image Courtesy of Dimensional Fund Advisors

You may notice that I wrote “was associated with a 77% reduction in…”  That is correct.  Investments do not emit greenhouse gasses on their own.  An investment, however, is a bit of ownership in a company (in the case of a stock), or a loan to a company/government (in the case of a bond).  Thus your investment dollars are associated with, or aligned with, entities or projects that have higher sustainability scores (i.e. lower carbon emissions) in comparison with the other possible investments publicly available.  

What is the catch (or what are the downsides)?

The most common question people have when considering sustainable investments, is “what am I giving up?”  There are two sides to the question:  returns and risk.

Are you giving up returns?

The short answer is that we don’t expect future returns to be better or worse than the market.  Actual returns, of course, will vary.  In some periods, sustainably-screened investments will outperform.  In other periods, sustainably-screened investments will underperform.  We don’t expect any long-term outperformance or underperformance.  The reason is due to our core belief that markets work.  The market does a good job at pricing expectations for future growth.  Thus, if sustainable companies are likely to earn better profits due to some thesis like “dirtier companies cost more to run and thus will be less profitable,” then such an expectation is already factored into the share prices for those investments.  Actual results will, of course, vary from one time period to another.  However, that is likely more to do with natural variability than with a broader trend.  To view the current investment performance of funds with sustainability criteria, click on the “Learn more” link in the endnotes.

Disclosure:  Past performance should not be used to predict future investment performance.

What about risk?

The other question is:  does a sustainably screened portfolio have a lower (or higher) risk profile than equivalent non-sustainably screened investments?  Similar to the risk question, we do not expect a sustainably screened portfolio to be more or less risky than a non-sustainability portfolio, because the market already does a good job of pricing in expectations of risk.  Actual results of risk, of course, will vary.  In some time periods, a sustainably screened portfolio will exhibit less risk, and at other times it will exhibit more risk.  There is a small decrease in diversification, which in and of itself is a risk-reduction strategy, so a sustainably screened portfolio may have a slightly higher risk profile.  However, the magnitude of reduction in diversification is not massive in the case of a globally-diversified portfolio such as those managed by DFA, as the number of investments is so large (over 11,000 in the sustainable portfolios, vs. over 13,000 in the non-sustainable).

Disclosure:  There is always the risk of loss when investing.

The Bottom Line

Dimensional Fund Advisors has crafted a line of investment products where an investor can align his/her/their environmental values with investments, without giving up strong investment principles, or expected future returns.  We like the process, we are impressed by the implementation, and we personally own sustainably-screened investments managed by DFA.  To learn more about how DFA manages it’s suite of sustainable investment products, click on the image or link below.

DFA Sustainability webpage

End Notes

• To read more about Dimensional Fund Advisors (DFA), and their approach to constructing investments, please visit their webpage:  Dimensional Fund Advisors website
• The DFA sustainability page has much more information and links to information about the actual sustainable funds:  DFA Sustainability webpage
• The World Wildlife Foundation (WWF) has a nice page discussing the Palm Oil industry, and how that industry is changing.  WWF Palm Oil Context
• For information about the link between carbon emissions and Climate Change, there are many reputable sources.  Two good ones are:
  • The intergovernmental Panel on Climate Change (IPCC)’s webpage is managed by the United Nations, and is good source for information
  • We (John actually), wrote a blog post on the connection:  Sustainable investing – add some green values to your portfolio
  • The Simpsons had a 2-minute clip called “Global Warming” that is entertaining, quick, and reasonably accurate for the link between greenhouse gasses and climate change. The clip ends in ridiculous solutions, which of course are complete silliness, a la Simpsons!

Disclosures

• John Chesbrough CFP® owns positions in the DFA Sustainability set of investments (Specifically mutual funds with the symbols:  DFSIX, DFSPX, DESIX and DGSFX or the Exchange Traded Fund equivalents of DFSU, DFSI, DFSE or DFSB)
• Elizabeth Snyder CFP® owns positions in the DFA Sustainability set of investments (Specifically mutual funds with the symbols:  DFSIX, DFSPX, DESIX, DGSFX or the Exchange Trade Fund equivalents of DFSU, DFSI, DFSE or DFSB)