One Day in July seeks to build its environmentally focused portfolios with an emphasis on the same key investment criteria that we believe are critical to all portfolios. Among these are low cost, substantial diversification of risk across industries and geographies, a high degree of liquidity and transparency in the investment vehicles we use, and a competitive level of current income.
Nevertheless, because certain types of stocks are less compatible with an environmentally focused mandate, there will invariably be some differences among investment characteristics in these portfolios relative to the portfolios we manage that do not consider environmental factors (“baseline portfolios”). We believe that these differences are generally modest. However, they are still worth noting since they may periodically cause performance of an environmentally focused portfolio to diverge in either direction from the performance of a comparable baseline portfolio.
Because some industries are more exposed to the environmental metrics we have chosen to emphasize (carbon intensity and fossil fuel reserves), these industries are less prevalent in our environmentally focused portfolios than in our baseline portfolios. Not surprisingly, the Energy and Utility sectors are among those with lower weightings. There is also less exposure to Basic Materials and Industrials, areas which tend to have higher average emissions due to the presence of energy-intensive activities such as mining, construction and transportation.
The exposure that would otherwise have gone to the above industries is redistributed among industries with a lower environmental footprint, including Consumer Staples, Health Care, Financials, and Technology. As such, these sectors typically carry a larger weight in the environmentally focused portfolios than in our baseline portfolios.
As a rule, our environmentally focused portfolios will have a somewhat larger allocation to growth-oriented companies as opposed to value-oriented companies. Companies in the Energy and Utility sector tend to fall into the Value category, as their growth rates are often slower, but steadier, than the market average. Growth companies, by contrast, tend to exhibit faster sales and earnings growth, but also may be more volatile, particularly during large market moves.
The dividend yield of our environmentally focused portfolios is likely to be somewhat lower than that of our baseline implementation. This is related to the above-mentioned bias toward Growth companies. Growth companies tend to produce more of their long-term returns through appreciation in the stock price, whereas slower-growing Value companies tend to pay out more of their current earnings in the form of dividends to investors.
Environmentally focused portfolios generally have a slightly lower allocation to large-cap companies than our baseline portfolios and a commensurately higher allocation to medium and small-cap companies. One key reason for this is the prevalence of companies with fossil fuel exposure in the large-cap bucket.
Historically, small-cap and mid-cap stocks have exhibited both higher returns and higher volatility than large-cap stocks, although there are periods where the opposite occurs as well.
Relative to our baseline portfolios, environmentally focused portfolios tend to have slightly less exposure to U.S. companies and slightly more exposure to other developed economies in Europe and Asia. The European Union in particular has moved more quickly toward lower carbon emission targets than the U.S.1
Additionally, our environmentally focused portfolios will have lower exposure to Emerging Markets stocks. This is primarily due to the higher proportion of emerging economies that are oil producers and energy exporters, including Russia and several Latin American countries.
1"Are S&P 500 companies prioritizing environmental sustainability?" Refinitiv, October 10, 2019.