Do ESG mutual funds really solve the needs of socially conscious investing?

Hardip Walia, chief executive of digital brokerage Motif, says such products are falling short, because they don't actually reflect the values of an investor, but rather a fund company.

The firm conducted a survey of investor attitudes and found the majority of respondents didn't know what was in their investment holdings, nor whether their investments were actually aligned with their own values.

So Motif partnered with MSCI ESG Research to evaluate investments on the social values an investor tells the firm are most important to them. Companies that don't fit are replaced in portfolios with those that do. Motif is offering three value themes to start - sustainable planet, fair labor, or good corporate behavior - and will add more over time, Walia says.

Walia challenged the mutual fund industry, saying that investors have been provided little choice to invest with their values in a meaningful way. Unlike most digital wealth management platforms, Motif doesn't put investors into a fund, but rather lets them invest directly in shares of a company through its service.

"We're voting with our consumption dollars, but not our investment dollars," Walia says. "We're blindly giving [our money] to the Vanguards of the world, who then vote, and we're passive."

Walia spoke with Money Management Executive about the attitudes of investors, and the inadequacies he sees with contemporary environmental, social and corporate governance investing and funds.

An edited transcript of the conversation follows.

Values investing and transparency are now a focus for Motif. Why?

We did a survey. Post-election, 83% of Americans will tell you that values are important when it comes to investing decisions. Sixty-eight percent say it is actually an important decision criterion; 57% say they would be angry if they were to find out their money is going to things fundamentally different than who they are.

My wife drives me nuts to make sure I recycle. So I said, "For all the effort you make me do, we should fix your portfolio because your money is going to go to global warming." She asked me, "How do I know what's in my portfolio?" I said, "You don't."

It is remarkable in this day and age that we know what nets we use to capture our fish, but I can't answer, 'What am I invested in?' Obviously if you're high-net-worth, all you do is SMAs, but for mass affluent especially, I can't tell you what's in your portfolio.

What about an index portfolio?

You still don't know because they have an index that they have a responsibility to track, but they can go off. And even then it's ridiculously hard to find out.

ESG is a hot trend but it makes no sense, because if I can't tell you what's in an ESG fund, then there is no such thing as ESG. My wife will argue biotech's bad, but I think biotech's good, and in an ESG product I have no idea what the prevailing view is. You almost have to outsource your brain and your values while doing ESG investing.

Think about Vanguard. They're amassing all this power with passive investing, how are they voting? Why are they taking my votes away, right? And again, we're seeing it in the consumer world of everyone is voting with their dollars. I'll buy like a recyclable cup at Starbucks because it's for the environment.

So we wanted to do two things with this product. We wanted to take our transparency, and allow people to manage wealth in an easier way. And I wanted to do something about values.

It is a national discussion right now, it used to be a conversation you and a bunch of friends would have over dinner. Now it's a national conversation, everyone is talking about values and how important it is; whether we fund Planned Parenthood, for instance, people care about where their dollars are going, and yet there's the big pool of assets where people have no clue. And those decisions get delegated to people who may or may not share your values.

We've created an automated investment tool, where you can build a wealth solution, but the difference between ours is on top of asking you what your financial goals are, we are going to ask you what values you care about.

My wife will say I don't want to do anything that has a negative impact on the environment and I'm literally going to rip the stocks that don't align with your values out of your portfolio, show them to you, and I'm going to take alternative ones to keep your model.

Isn't there a value judgment in determining one's values?

That's actually right. So we've done two things, because we didn't want to make those decisions.

We are partnering with MSCI with their ESG research and we're going to let them justify and put the data on why a company is good or bad, why it aligns with a certain value or not. But the difference here is unlike any ESG fund, if you disagree with what we're doing, you can change it, which you can't do with a fund.

So the notion of ESG and funds are kind of an oxymoron, because they really can't represent your values. If you put on the ESG label and I don't tell you what I'm doing, all I do is charge you more for the ESG label. Our model is we're giving you a baseline. I have a view on the market, I want to invest in a given trend, but if I disagree with it, I can refine it, I can tweak it, I can make it better.

You get to pick a value. We're starting with sustainable planet, which deals with climate change. We also have labor practices - I don't want people in child labor in developing countries making my sneakers, it bothers me. And then corporate governance, which may not be sexy, but these days is a pretty important thing for many people.

Personally, it's one of my important values. I want to invest in companies that don't have crony boards because it actually makes good ROI. There were many people who thought there was something wrong going on at Volkswagen, and they pulled out their money. So you get to pick those values as part of building your investment plan.

What have you learned from building this product?

I didn't know that many Americans really used values as a decision maker. And it kind of makes sense. If you think about it, we make food choices based on values. We want to know where our money is going in terms of lobbying and governance. I can now Google anyone and see who they gave money to.

We're going to get into ESG on the institutional side, but first I want to solve a very simple problem: Where's my money? Where is it going? What is it funding? And our target audience, luckily, consists of two people: people who have money and people who care about where their money is being used. We found that 83% care, but only 42% are doing something about it. When you talk to that 42%, how they're doing it is buying ESG products, and that's not enough, because it doesn't solve their problem really well.

That gap is what we're going after. Millennials, smaller account balances, women. What's in our favor is the growth. I mean the growth of people caring, people investing in what they value. I definitely will not invest in companies that contradict my values, I just won't. I have thatluxury but the average investor, they're struggling. They want to do it, but they see no good options and the easiest response is, "I'll buy in the ESG ETF and feel better," but that really doesn't solve their problem.

Some digital platforms are now tailoring appeal to specific minority groups and cultures. Is that part of a values-driven approach too?

It's an interesting idea, I actually hadn't thought about it in those terms. But I think what differentiates investors is less about whether I'm Hispanic or Indian American, it's a set of value systems. And I would never want to genericize about knowing what a community is, because even within a given community there are a diversity of opinions.

So, the key to serve clients better is not unloading raw information on them, but rather better curated information?

You go to a restaurant, and you have the calories on display now on the menu. No industry voluntarily does that, consumers demand it. The problem is they need some sense of what's going on to do so. Investing is complicated and a lot of consumers don't even understand how interest rates affect their lives, so you've got to give them kind of the seed data.

The fee argument is pretty compelling too. I was reading a study that found over the lifetime of a 401(k) account, a third of the return goes in fees that you don't see. So back to transparency then; for all the passion around the fiduciary rule, if I can't answer the simple question of where is the money going, how do you build any regulatory framework?

The easiest way to protect the investor is empowerment. And empowerment starts with fundamental data, and making it easy. We're trying to jump ahead of the trend and we're going to give the information to you. And we're going to do this on our institutional side, as well. This is not just a retail thing, because with it comes responsibility.

Again, we vote today with consumption dollars, which is good, but we should be voting with investing dollars, since that is a multiple of our consumption dollars. But nobody is thinking and we're blindly giving them to the Vanguards of the world who then vote. And we're passive, but we're not a passivist culture. Look at the streets, the protests they're having, all of this blends to a common theme. So we're pretty excited about the product because we think it's a product of our times, especially now.

I read that consumers need to trust the manager. Why, what if they don't earn my trust? Slapping an ESG, save the world label doesn't do anything if you can't show me and prove to me what you're doing.

Do you think the idea of an active manager is now antiquated?

No, I don't. I am a big proponent of active management. The way we view the world today, there is insight, there is the account, there is product, there is advice, and there is consumption. I own a mutual fund, I have an active strategy, it's in an IRA, it's delivering through the mutual fund distribution channel. I may or may not have a financial adviser and I am a high-net -worth investor.

This is me today, this is the industry today, and this is vertically integrated. It all comes as one package. What we think is going to happen is this is going to get unbundled.

So eventually insight, and they can be passive, they can be active, they can be alternative, there's a whole set of insight styles, this is what the portfolio manager does.

The problem today is I have to package it, and actually these guys are getting all the value. Value is actually migrating away from manufacturers and going to people who own distribution.

We can argue where the value is actually created, but where the value is going is very clear. What I'm saying is, this mutual fund concept, it needs to go, it is antiquated. ETFs are a step in the right direction, though they are not perfect.

There is a role for advice, I do think there is a role for a portfolio manager. But combining it and making it inflexible and making it this one-size-fits-all solution? That's my biggest critique of robos too: everyone on the planet gets the same basket of 10 ETFs. That's not innovation.

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