Responsible Investing: Can I Put My Money Where My Mouth Is?
I care about social and environmental impact, but I also want to make money.
Can I do both?
I used to believe people either saved money or saved the planet. They were mutually exclusive. Tie or tie-dye, Invest-in-stocks or wear Birkenstocks... you get the idea. A choice had to be made - what type of person was I going to be?
In my naive black-and-white worldview, people who liked money looked only at their returns over one, five and ten year periods. The other people immediately caught companies like Phillip Morris, Halliburton, and Horrible Blood Diamonds Inc. in the prospectus and saw a red flag kept them from investing. Despite both sets of knowledge, I'm sure I've made earnings from mutual funds with disguised "sin company" holdings. I am the ultimate HYPOCRITE!
There weren't really any investing options for my idealist thinking, or so I thought. 'Can't I invest in a better world?' Money managers laughed at me. I was called cute. I tried to explain - I wasn't looking to profit off of environmental destruction and exploitation of people far away. I have since learned it's far more gray - most people feel a blend of wanting to make money, but with a conscience. Today I ask the same question:
Can I avoid retiring on earnings from war, clearcutting forests, child labor, and other injustices? Is it possible to make money and support social and environmental wellbeing?
The logical place for me to start was SRI funds (socially responsible investing). They are few and far between, but as you can see below, millennials are changing that.
Only about 2% of the fund universe is comprised of SRI funds, which exclude the "sin" sectors. SRI companies avoid businesses associated with alcohol, tobacco, gambling, fast food, weapons, fossil fuels, or military. With less diversification, all of my eggs are in one basket with this strategy. We try to avoid this as we know a diverse portfolio (and economy and ecosystem) is a stable one. The downside is you don't make money off a profitable war. The upside is you don't make money off a profitable war.
Responsible investing isn't a new concept, but the hurdle lies in transparency and the ability to track large data. There's also a long-held paradigm that saving the environment sacrifices economic returns. This belief is changing as we have officially traded coal for renewables, and now companies have appointed "sustainability directors" and a triple bottom line. Led by the 350.org movement, 40 universities, including Stanford, and faith-based institutions have made commitments to divest their 8-9 figure endowments away from fossil fuel holdings.
Those Birkenstock people are shifting the investment strategies of institutions that oversee billions in endowment. Maybe you and I can choose some wiser place to put our money than Blood Diamond Inc. One such opportunity opened for us in 2016, as the financial industry shifted towards greater corporate accountability with the release of the Morningstar Sustainability Rating.
According to Morningstar, this new system provides a "reliable, objective way to evaluate how investments are meeting environmental, social, and governance challenges. In short, it helps investors put their money where their values are."
I was interested in putting my money where my mouth is, but as a natural skeptic, I was curious about the strength of criteria used to assign companies a 'sustainability globe' (like a quality star). I'm jaded from the onslaught of inauthentic eco-babble spewed from corporate. After reviewing their metrics, I began to decipher some truth. Sustainalytics is a third party company that collects big data from publicly traded companies. They use this portfolio sustainability score calculation:
Portfolio Sustainability Score = Portfolio ESG Score – Portfolio Controversy Deduction
The ESG score represents how well each company in the holding manages their Environmental, Social, and Governance risks and opportunities - i.e. how shitty or not shitty they are. The second part of the equation subtracts any ESG controversy (i.e. big shitty event like an oil spill), leaving a score out of 100.
Truly calculating a business' impact is far more complex, but this is the general gist. For the nerds who want more detail about asset-weighting, peer group comparison, and the use of standard deviation check this out. Other important points are only companies that have ESG scores are evaluated, and at least 50% of a portfolio’s assets under management must have a company ESG score. It's as accurate as it can be, given the convoluted nature of global finance.
Since it's unveiling, the sustainability rating (which uses up to five globes) has become commonplace language amongst investors, and now their clients. Some think it's BS - the criteria are too loose and have little influence on corporate responsibility or real investor's decisions.
Others see it as a place to start. This criteria-driven label is not pioneering new green frontiers, it's barely catching up to the growth and interest in responsible investing that came on the scene more than a decade ago. Instead of inheriting the risk of a SRI fund, the ratings allow the investor to tilt their portfolio towards sustainable business practices. We can now invest in companies that align with our values, at least based on the criteria of the globe rating system.
Jill the investor has her eye on two large cap growth funds (large-sized bundle of companies). Both have performed consistently well over a 10 year period, but Fund A has a two-globe rating and Fund B has a 4-globe rating. Jill could feel good about her choice in Fund B in regards to both potential earnings and corporate responsibility.
Another complimentary approach is to look at ESG Index funds with a large asset size. The advantage here is the large fund managers have done their homework - vetting fund operations, investment selection, and trading practices - something an individual investor could never do. As a result, the vast amount of screening done by the large funds drives up the fund's expense ratio when compared to a standard Vanguard Index fund. Here's information on the top Electronically Traded Funds with a social responsibility focus. I'm starting to look for the following equation:
Good performance + large asset holdings + low expense ratio + ESG tilt = $ + peace of mind
So, if you have ever felt that fear of investing in an unsavory company, now there is some transparency that shines light on companies with good environmental, social, and corporate responsibility. I am not going to uproot my entire portfolio to invest only in wind energy and small-scale organic farming. If I practiced what I preach (and teach in the classroom), I should divest entirely and use that money to promote the issues I care about. Alas, I am still a hypocrite.
What I am doing though is looking through my investments and identifying the funds that are solely or primarily comprised of companies from military or oil sectors. They are now gone and are replaced with mutual funds with comparable growth and 3-5 globe ratings. These funds, which score high using the Morningstar metrics, may still contain companies like Exxon, Chevron, or even Philip Morris. Remember, the bulk of the fund scores well in the ESG ratings AND you're still in a diversified investment.
Birkenstocks - you're losing out if you don't jump in. Invest-in-stocks - consider glancing at the globes next time and considering where your earnings originate. Me? Well, I certainly don't have it all figured out, but I'll be continuing to learn how to make better personal and ecological decisions towards early retirement.