Many clients want to see their values reflected in the investments they hold. That’s nothing new, of course some investors have long avoided alcohol, tobacco and weapons makers for religious and other reasons, and what became known as socially responsible investing took off about three decades ago when some investors began to avoid companies doing business in what was then apartheid South Africa.

Yet the world of what one might broadly label values-based investing has changed and expanded significantly in recent years. This type of investment is often as much about including companies as excluding them.

“There’s been a trend over the past decade toward positive screening,” says David Kathman, a Morningstar analyst who tracks funds that seek to be socially responsible in their investment choices. Kathman notes that the modern take on social investing is that “if you try to find the most positive companies, you’re going to eliminate the really bad ones.”

The terminology has changed, too, in part because the old SRI strategies had an uneven track record for performance, excluding some high-performing sectors and industries.

Some practitioners of this type of investing now call it ESG for the environmental, social and governance factors they consider when buying shares of companies. Deb Wetherby, CEO of San Francisco–based Wetherby Asset Management, prefers the broader term “impact investing.”

Clients want more than just a financial return, Wetherby says — adding that many people come into her office saying that they want their investments “to be more consistent” with their social values.

“Overall, impact [investing] focuses on having your investments have more than one purpose,” she explains.
Values-based investing has been largely a niche sector, albeit a growing one. But some advisors expect generational changes to affect future growth. Wetherby and other advisors believe that millennials will increasingly demand a social dimension to their investment portfolios.

“They are driving a lot of that change,” says Gigi Turbow Marx, founder of Old Field Advisors in Melville, N.Y. She adds that some young investors who have made their fortunes at successful tech startups are at the forefront of the current social investing trend.


Just as the labeling varies, so do the actual selection criteria, with a wide range of standards that may be applied in creating portfolios. “You can’t assume that just because something is labeled SRI or ESG that you know what it’s going to do,” Kathman says. “You have to look at the screening criteria for each individual fund.”

So variable are the requirements of potential clients that Calvert, one of the oldest values-based fund shops, has developed multiple approaches. “Our view is that you can be a responsible investor in the 21st century by avoiding companies that have significant sustainability problems and shortcomings, or by owning them and allowing us to undertake very significant advocacy,” says Bennett Freeman, senior vice president of sustainability research and policy at Calvert Investments.

For Calvert, that means three different fund categories. The company’s Signature funds have the most comprehensive standards and the most exclusionary criteria; Freeman says they include about two-thirds of the investable universe. The Solutions portfolios, by contrast, invest in companies that can make a difference in fields like water management and alternative energy.

Calvert’s Sage funds could be said to differ the most from traditional SRI portfolios. “We employ fewer criteria, but in return, we commit to our shareholders to [employ] a very focused, aggressive advocacy,” Freeman says.

Advocacy from within doesn’t sway some people in the values-based investing community. “We have to avoid some of the pariah companies,” says Steve Schueth, president of First Affirmative Financial Network — a Colorado-based third-party money manager that specializes in socially responsible investing, with the vast majority of assets coming through a network of affiliated advisors.

Schueth doesn’t see much benefit in owning shares of companies like ExxonMobil or Altria and filing shareholder resolutions to “try to get them to walk away from their core business.”

After excluding the pariahs, First Affirmative focuses on “best of class” firms that it can own. Client portfolios that are less than $300,000 are constructed with mutual funds. Those above the cutoff can be customized down to the account level via the Folio Institutional platform.


Take one area of avoidance: oil and gas producers. Many ESG advocates say that owning shares of fossil fuel producers creates its own set of uncertainties, because of the concept of “stranded assets.” Oil and gas producers are valued by the fuel reserves they control — so if future carbon-emission regulations prevent them from exploiting those reserves, the shares of these companies could be significantly overvalued.

“Any planner or firm that bills itself as a fiduciary needs to understand that they need to start addressing that challenge,” Marx says.

First Affirmative allows clients with larger portfolios to eliminate a single company or all the major carbon emitters, Schueth says: “We can custom-code each client account never to go into certain securities.”

At last count, Schueth says, 161 clients have instructed First Affirmative’s advisors to remove all fossil fuel producers from their accounts. In their place, the firm adds stocks with similar risk/reward profiles, with a heavier emphasis on renewable energy companies. “We believe and our clients believe that those are the companies that are creating the future,” Schueth says.

Introduced less than two years ago, the fossil-fuel-free portfolios are too new for anyone to determine if they will outperform or underperform more traditional strategies. When clients ask for them, Schueth says, his affiliated advisors make sure to discuss the uncertainties.

Not even all ESG advocates agree with the stranded assets theory. Although Calvert’s Freeman would like to see energy companies take an “accelerated shift away from hydrocarbons,” he cautions that just because a shift is imperative, that doesn’t make it inevitable.

“We wish it were inevitable; we wish it were, indeed, imminent,” says Freeman — but he concludes that a shift away from fossil fuels won’t happen in the near term because of gridlock in the U.S. political system. “We take it very seriously at Calvert,” he adds, “but we just don’t think it’s an investable premise yet.


For advisors who tend to favor passive strategies, values-based investing can pose a challenge, because a majority of traditional funds in the sector are actively managed. “There aren’t that many broad-based SRI index funds anymore,” says Morningstar’s Kathman.

But there are a few, he points out — including funds based on the MSCI KLD 400 Social Index, one of the oldest benchmarks in the category. MSCI’s website notes that the index “excludes companies involved in alcohol, tobacco, gambling, civilian firearms, military weapons, nuclear power, adult entertainment and genetically modified organisms.”

Green Century Equity (GCEQX) tracks a version of the index that also excludes fossil fuel companies. The traditional index is also available through the iShares MSCI KLD 400 Social ETF (DSI).

And ETFs in the values-investing space are overwhelmingly index-based. They also tend to be specialized products focusing on wind power, solar energy or water resources — which, Kathman says, makes them easier to construct and manage. “It’s fairly easy to have an index of alternative energy stocks that you can track,” he says.


At least one major player has tried to come up with new measurement standards for broad values-based investments. Last year, Thomson Reuters launched a suite of benchmarks that track ESG factors in large-cap stocks within the U.S., in developed markets outside the United States and in emerging markets. Called the Thomson Reuters Corporate Responsibility Indices, the new indexes were developed jointly with S-Network Global Indexes, a New Yorkbased specialty index publisher.

No investment products based on these benchmarks yet exist, but Herb Blank, S-Network’s managing director of ESG solutions, says discussions are taking place with several ETF firms that could bear fruit in 2015.

Blank describes the large-cap U.S. index as an ESG-aware version of the S&P 500. Its close correlation with that traditional benchmark is achieved, in part, by using ESG standards for half of the weighting and market capitalization for the remainder.

The new indexes come in four versions with an overall ESG standard and benchmarks screened specifically for environmental, social and governance factors. That leads to some unusual rankings.

Apple, the largest company in the S&P 500, holds the same position in the Thomson Reuters CRI environmental and governance lists, but is missing from its social and overall ESG indexes. “They have a very strong environmental score and a very poor social score,” Blank explains. The social score includes labor practices, safety and health, and disclosure policies.

And ExxonMobil, the energy giant, makes the cut in all four versions of the Thomson Reuters CRI U.S. large-cap benchmark. That raises eyebrows with First Affirmative’s Schueth, who says that his clients “would have conniptions” if a company like Exxon were included in their portfolios.


Another challenge for advisors is finding a values-based approach in the fixed-income arena. Firms including Calvert and TIAA-CREF have launched fixed-income funds in the space, but other choices may not be obvious.

Melissa Lopez, co-chairwoman of the impact investing committee at Wetherby Asset Management, cites the bond giant PIMCO’s Total Return III fund (PTSAX) as one example of a fixed-income fund that “applies screens that consider ESG factors.”

And Marx, of Old Field Advisors, suggests that values-based investors consider municipal bonds. “What are munis financing? They’re financing community needs,” she says.

That’s a theme that also resonates with Schueth. “In a muni bond fund, there’s very little chance that you’re going to have something in there that’s going to cause heartburn for a client,” he says.


Advisors may have another concern: Whatever the labeling, do the screens’ exclusions force investors to accept lower returns? Morningstar’s Kathman says no: “It’s certainly true in the short term that there can be a lot of variation [in performance], but over the long term, it tends to even out.”

Academic studies appear to back him up. A study of the 1992-2007 returns of SRI funds published in the July/August 2009 Financial Analysts Journal found that “the advantage from tilting toward stocks of companies with high social responsibility scores is largely offset by the disadvantage from the exclusion of stocks of shunned companies.”

A more recent study covered U.S.-listed stocks in the Thomson Reuters CRI database during the post-financial-crisis period of 2008 through 2013. Indrani De, director of quantitative research at asset management firm New Amsterdam Partners, conducted the study; she says that investors who use ESG screens should be pleased. “The highest return companies are always from a better ESG-rated group,” she says.

They also tend to be less volatile. “That relationship becomes even stronger when market volatility picks up,” De adds.

Morningstar data covering U.S. large-cap SRI and ESG funds also shows their average performance in line with the total return of the S&P 500, although a bit below it in all five periods measured. (See chart above.)

The larger question may be how effective these portfolio strategies are as an agent of social change. But Wetherby, for one, urges investors to take it seriously.
After all, she says, “everybody laughed at South Africa divestment — until it actually worked.”

Joseph Lisanti, a Financial Planning contributing writer in New York, is a former editor-in-chief of Standard & Poor’s weekly investment advisory newsletter, The Outlook.

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