But the challenge is even greater when an adviser is faced with the prospect of dealing with both of those challenges in one portfolio, by investing sustainably for income.
As many of the equity sectors traditionally favoured by equity investors include oil, mining and tobacco, many are unlikely to be in sustainable equity portfolios. Many of the staples of sustainable portfolios, such as renewable energy, are early-stage businesses that may not yet be at the point of paying dividends.
Simon Holmes, director and portfolio manager in the multi-asset team at BMO, says: “It is the case that traditional sources of income include several areas that would be excluded from a sustainable portfolio, such as tobacco and fossil fuels.
"Options for income seekers are indeed narrowing, with sectors that traditionally provide the highest yield also [being] the most impacted, and most greatly exposed, to disruptive trends, including the retail and banking sectors. This means investors who are chasing dividend-paying companies could find themselves in value traps or overexposed to sectors in permanent decline and/or with volatile dividends – such as the tobacco or energy sector."
The challenge with sustainability is defining it John Teahan, RWCHe adds: "However, by investing in companies whose products and services contribute to solving some of the world’s most pressing sustainability challenges, not only do they have a direct positive impact on the world, but they will also benefit from long-term secular tailwinds. This ensures they can generate robust and growing streams of cash flows that underpin secure and growing dividends.”
John Teahan, equity income fund manager at RWC, says: “The challenge with sustainability is defining it. For example, electric-car-makers need copper, demand for copper will rise sharply in the years to come as people focus on that, but it is the traditional miners who are copper producers. So if we want to transition, we need the miners, and demand could be four to six times the current level.”
He notes that certain mining companies are “more green than others, but one thing we want to do is work with the miners who are improving their safety and risk controls, for example".
Teahan adds: "On the oil side, you have a process where companies are using the cash flows they generate from their current activities to fund renewable energy investment, and we need that investment. Of course, not all oil companies are behaving in that way, but those that are need the support of shareholders.”
He says value investors tend not to buy the established renewable energy players on valuation grounds, but buying the companies that environmental, social and governance funds may not buy, in areas such as mining and oil, represents an opportunity.
Investment spectrum
Dan Hanbury, head of UK equity smaller companies, equity income and core strategies at River and Mercantile, says: “Part and parcel of looking out for more sustainable income streams involves being wary of the business models which, increasingly, will have a shrinking role to play over time, unless they innovate further and change how they operate.
"There are names where we have concerns about how they allocate capital going forward, against a backdrop of a government target to reach net-zero emissions over the next 30 years. For example, while there is little doubt that the big oil companies’ transformation intentions are impressive, on a long-term view, most of these businesses still face real challenges and ones which it is far from clear they can overcome.
"Stranded assets and a track record of poor capital allocation are material risks that threaten their business models and future dividends."
Hanbury adds: "We are firmly in favour of engagement and improvement rather than exclusion as a policy, so we now only have a small exposure to the UK’s oil majors and this is only while the oil price recovers in the face of significant stimulus and an economic recovery.
"But we do still have energy-related investments in our portfolios. One area of focus is energy companies operating at the more sustainable end of the spectrum, with names like [Diversified Energy Company, formerly] Diversified Gas and Oil, a good example of this.
"[Diversified Energy Company] is consolidating the North American conventional gas market where they improve the efficiency of the wells. Gas is the cleanest form of the fossil fuel energy sources, and so is critical to powering the economy through the transition period and beyond. As such, it is one name we are happy to own in place of oil exploration companies."
Another example is Smart Metering Systems, the smart meter installer and operator. Smart metres are now mission critical when it comes to the UK’s efforts to reduce its carbon emissions, helping to control how and when we use power in our homes.
Ben Needham, an income portfolio manager at Ninety One, says the key is to find companies that are tech enabled and so can grow in a way that does not require investment in areas such as buildings and plant, which impact the environment.
BMO's Holmes says there are areas of opportunity in businesses such as healthcare, where some of the largest pharmaceutical companies in the world are offering good yields, as well as some of the property investment trusts.
John Fleetwood, director of responsible and sustainable investing at Square Mile, says he believes those who are seeking sustainable income should avoid oil and mining.
He says the crux of the income investing dilemma is that, in the past, attaining a 5 per cent yield from a portfolio would have been quite easy, but to do so now probably means taking income from capital gains.
This means, for example, if a portfolio rises in value by 8 per cent in a year, then that would mean selling a portion of the investments to raise an income.
He observes that in current market conditions, paying an income from capital is “inevitable”.
But among the sustainable income investments he likes are infrastructure investment trusts, investment trusts which invest in social housing, and also funds which invest in green bonds.
The UK government, in common with many other governments around the world, has issued bonds that are designated 'green', and so will not be spent on activities that do not comply with ESG considerations.
The first of these bonds was issued on October 22 with a yield of 0.65 per cent, which Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, says is sufficiently low that demand for the product is likely to “wither” after an initial period of optimism.
David Thorpe is special projects editor at FTAdviser
