If you know me, you know that I’m a finance nerd. I love exploring concepts that help leverage resources to create exponential growth. While this series of posts have been trying to use that philosophy and applying that towards giving, I’d like to merge the two fields here. This whole series has been about showing that we don’t have to decide on what is best for us over what is best for others—we can do both. We can invest in our financial future while doing some good as well.
When it comes to investing, we generally have the mindset that it is a cut throat arena and as long as we get out alive, we can later turn around and do some good. We trade ethics for the bottom-line & earnings reports. But just as the market reflects what is demanded, we can shape the market to value more than just the bottom-line by investing in companies that are demonstrating positive societal impact.
This can be towing a political line here a bit, but I’m going to try to keep it apolitical here. One of the criticisms of financial markets is that encourages destructive behavior. This is severely oversimplified, but the value of a company is determined by the outlook investors have on the future of the company. Quarterly reports provide financial information that investors react to and that influences the price of the company stock. Thus companies are encouraged to do things that demonstrate positive financial reporting and will sacrifice options that have long-term implications for short-term growth in order to not scare off investors. Again, financial markets are way more complex than that.
But what happens when investors start reacting to metrics beyond financials? What if a company starts reporting a “triple bottom line” that reports its environmental impact and impact on stakeholders along with its financial report, and investors start rallying towards the stock when the environmental impact improves? The stock price is the imbedded market value, but what causes the price is subjective. If companies start seeing that their earnings report isn’t influencing investors as much anymore, but then see their competitors are gaining momentum with their social impact reporting, this could then help shift the market to value social impact overall.
Socially Responsible Investing
That is the macro financial theory, but on an individual level, this poses a question: what do you want invest in? Would you like to invest in a company that is investing in renewable energy or a pharmaceutical company that spends more money on discovering new cures than just holding onto patents? If you could invest in a company that was doing those things AND was growing in value, would you invest in that over a comparable company that did not demonstrate those positive outputs?
This idea of ethical investing has generally two branches: Socially Responsible Investing (SRI) & Environmental, Social & Governance investing (ESG). Both of these have loose parameters as they both are simply filters to observe companies through.
ESG is simply a term of evaluating a company based its environmental impact, it’s social impact, & the structure of its corporate governance. Companies can publish reports on how their company demonstrates these practices, and evaluators can also audit company based on these metrics. It’s vague, I know, but the organization, MSCI, has done a lot of work to help simply this whole process and have turned the ESG metric into a bond-rating scale. They audit public companies and evaluate based on those three parameters, and publish a final grade of how well the company demonstrates ESG values with a score from AAA (the highest) to CCC (the lowest).
SRI is more like a screener in that it takes the ESG format and but then tries to identify red flags and steer investors away from problematic companies. SRI is generally used in portfolio management in that you construct a portfolio of different investments, and your portfolio is considered to be SRI if it intentionally avoids companies that have been shown to do things that are considered unethical. SRI screens out companies like tobacco producers, gambling institutions, companies under legal investigation, or companies working with those that may be involved human rights violations.
Applying SRI & ESG in passive investing
Sorry, I know that wasn’t the most reader-friendly section, but I just wanted to break down how investments can be steered towards positive outputs.
This is again a how-to for doing good with minimal effort, and I’ll now show that just like the fitness apps can help you to do good while making it easier to get fit, we can support great companies and help invest in our own future at the same time.
Addressing where to invest is one part of this discussion, but the other part is how, and that is one of the biggest hurdles for many people. Regardless if we wanted to be socially conscious with our investing, the concept of investing is intimidating. Thankfully, there is a whole new market that has emerged that has stripped away much of the complexity of investing, and in general it’s called Passive Investing through online services called “Robo-Advisors”. I already wrote a detailed breakdown of how Robo-Advisors work, so I’ll just quickly summarize here.
When you have a long-term perspective of investing, risk in the stock market goes down significantly, because on average, the stock market increases by almost 10% per year. The problem is that is a macro observation of the stock market, with some companies doing really good, and some going out of business. If you put all your money in one company, and if it goes bankrupt, you can lose everything, even though the market continues to go up. The key to resolving this is through diversification, and Exchange Traded Funds (ETFs) help lump a bunch of companies together into a single investment.
Robo-Advisors are then services that take your personal preferences, and provide you a full portfolio of different ETFs and Bonds that allow you to passively invest. By being an online service, they can provide a fantastic service for a very low price (usually less than 0.5% per year).
The largest Robo-Advisor is Betterment, a web-based service that already manages over $14 Billion. In under 10 minutes, you can set up an investing account and start on a secure path towards long-term financial growth with a diversified portfolio based on your needs.
Betterment is a great service for the convenience aspect that we’re striving for here, but it also adheres to the SRI filter of investing. When you first sign up, you are given four portfolio options to choose from. Two of them are niche objectives that won’t appeal to the average starting investor, but the final two portfolios are nearly identical, with one being Betterment’s primary portfolio, and the other being the SRI version of that primary portfolio. The primary portfolio holds 11 different ETFs that range from large cap domestic stocks to small cap stocks & corporate bonds. The SRI version holds the same mixture of funds, but it trades out the ETFs for large cap domestic & the emerging markets for ETFs that have an SRI filter applied and weeds out any stocks that don’t meet SRI standards.
Betterment’s primary objective is to provide proper diversification with the least amount of disruptive fees. Fees are the silent killer to portfolio management, as even if you do achieve the market rate of 10% growth, you can incur high fees from the ETF itself, on top of what portfolio manager provides. Thus when approaching SRI, Betterment seeks to find funds that not only apply proper SRI criteria, but also keep fees low and allow for proper diversification. Thus currently they’ve replaced the two of the top three funds within the portfolio with SRI funds. As SRI continues to mature, new ETFs will continue to enter the market, and Betterment will continue to replace more funds with SRI funds (https://www.betterment.com/resources/socially-responsible-investing-portfolio/).
The two SRI ETFs are the DSI & the ESGE. The DSI is an ETF comprised of 400 of the largest U.S. Domestic stocks that have passed the SRI filter evaluated by iShares & scored a combined MSCI score of 6.6/10 (https://www.ishares.com/us/products/239667/ishares-msci-kld-400-social-etf).
The ESGE is another iShares fund that focuses on large & mid sized companies in emerging markets (China, India, South America, etc) that also demonstrate ESG values. This is particularly important, since U.S. domestic companies are held to higher reporting standards, and so biggest room for ESG improvement in one’s portfolio will come from the Emerging Markets sector. The ESGE has an MSCI score of 6.1, but ranks 97.76% on the peer scores in the Emerging Market sector (https://www.ishares.com/us/products/283777/ishares-msci-em-esg-optimized-etf-fund).
If you managed to read all of this, then you’re a real trooper. This post is particularly difficult since it combines two of the most difficult personal initiatives of investing and socially-conscious decision making. But like what this whole series tries to demonstrate, while they individually may be difficult, combining them into the same action may make the whole process more approachable. We can give money & energy towards social initiatives, but we can also invest in companies that are making a positive impact and make their success our success.
Betterment is the first step into blending investing with social impact, because it’s super convenient and user friendly. My next post will dive in deeper into how SRI can be taken a step further as you can have even more control over how you want to guide your investing towards particular social objectives.