Socially Accountable Investing Portfolios Methodology

Introduction

Betterment launched its first Socially Accountable Investing (SRI) portfolio in 2017, and has widened the funding choices beneath that umbrella since then. Inside Betterment’s SRI choices, we at present supply a Broad Influence portfolio and two extra, extra centered SRI portfolio choices: a Social Influence SRI portfolio (centered on social governance mandates) and a Local weather Influence SRI portfolio (centered on climate-conscious investments). These portfolios signify a diversified, comparatively low-cost answer constructed utilizing change traded funds (ETFs), which might be frequently improved upon as prices decline, extra knowledge emerges, and consequently, the supply of SRI funds broadens.

How can we outline SRI?

Our strategy to SRI has three elementary dimensions that form our portfolio development mandates:

1. Decreasing publicity to investments concerned in unsustainable actions and environmental, social, or governmental controversies.
2. Rising publicity to investments that work to handle options for core environmental and social challenges in measurable methods.
3. Allocating to investments that use shareholder engagement instruments, reminiscent of shareholder proposals and proxy voting, to incentivize socially accountable company conduct.

SRI is the normal identify for the broad idea of values-driven investing (many consultants now favor “sustainable investing” because the identify for your complete class). 

Our SRI strategy makes use of SRI mandates primarily based on a set of trade standards referred to as “ESG,” which stands for Environmental, Social and Governance. ESG refers particularly to the quantifiable dimensions of an organization’s standing alongside every of its three parts. Betterment’s strategy expands upon the ESG-investing framework with publicity to investments that use complementary shareholder engagement instruments. 

Betterment doesn’t instantly choose corporations to incorporate in, or exclude from, the SRI portfolios. Reasonably, Betterment identifies ETFs which have been categorised as ESG or comparable by third-parties and considers internally developed “SRI mandates” alongside different qualitative and quantitative elements to pick out ETFs to incorporate in its SRI portfolios. 

Utilizing SRI Mandates

One facet of bettering a portfolio’s ESG publicity is decreasing publicity to corporations that have interaction in sure actions which may be thought-about undesirable as a result of they don’t align with particular values. These actions could embrace promoting tobacco, navy weapons, civilian firearms, in addition to involvement in latest and ongoing ESG controversies. Nevertheless, SRI is about extra than simply adjusting your portfolio to reduce corporations with a poor social impression. 

For every Betterment SRI portfolio, the portfolio development course of considers a number of internally developed “SRI mandates.” Betterment’s SRI mandates are sustainable investing targets that we embrace in our portfolios’ exposures.

Shareholder Engagement Mandate

Along with the mandates listed above, Betterment’s SRI portfolios are constructed utilizing a shareholder engagement mandate. Probably the most direct methods a shareholder can affect an organization’s determination making is thru shareholder proposals and proxy voting. Publicly traded corporations have annual conferences the place they report on the enterprise’s actions to shareholders. As part of these conferences, shareholders can vote on plenty of subjects reminiscent of share possession, the composition of the board of administrators, and govt degree compensation. Shareholders obtain info on the subjects to be voted on previous to the assembly within the type of a proxy assertion, and might vote on these subjects by a proxy card. A shareholder may make an express suggestion for the corporate to take a selected plan of action by a shareholder proposal.

ETF shareholders themselves don’t vote within the proxy voting means of underlying corporations, however moderately the ETF fund issuer participates within the proxy voting course of on behalf of their shareholders. As buyers sign rising curiosity in ESG engagement, extra ETF fund issuers have emerged that play a extra energetic position partaking with underlying corporations by proxy voting to advocate for extra socially accountable company practices. These issuers use engagement-based methods, reminiscent of shareholder proposals and director nominees, to have interaction with corporations to result in ESG change and permit buyers within the ETF to specific a socially accountable desire. Because of this, Betterment features a Shareholder Engagement Mandate in its SRI portfolios. 

The Challenges of SRI Portfolio Building

For Betterment, three limitations have a big affect on our general strategy to constructing an SRI portfolio:

1. Many present SRI choices available in the market have severe shortcomings.

Many SRI choices at this time sacrifice adequate diversification applicable for buyers who search market returns, and/or don’t present buyers an avenue to make use of collective motion to result in ESG change.

Betterment’s SRI portfolios don’t sacrifice international diversification. Per our core precept of worldwide diversification and to make sure each home and worldwide bond publicity, we’re nonetheless allocating to some funds with out an ESG mandate, till passable options can be found inside these asset lessons. Moreover, all three of Betterment’s SRI portfolios embrace a partial allocation to an engagement-based socially accountable ETF utilizing shareholder advocacy as a way to result in ESG-change in company conduct. Engagement-based socially accountable ETFs have expressive worth in that they permit buyers to sign their curiosity in ESG points to corporations and the market extra broadly, even when explicit shareholder campaigns are unsuccessful. 

2. Integrating values into an ETF portfolio could not all the time meet each investor’s expectations.

For buyers who prioritize an absolute exclusion of particular forms of corporations above all else, sure approaches to ESG will inevitably fall wanting expectations. For instance, lots of the largest ESG funds centered on US Massive Cap shares embrace some power corporations that have interaction in oil and pure fuel exploration, like Hess. Whereas Hess won’t meet the standards of the “E” pillar of ESG, it may nonetheless meet the standards by way of the “S” and the “G.” 

Understanding that buyers could favor to focus particularly on a sure pillar of ESG, Betterment has made three SRI portfolios accessible. The Broad Influence portfolio seeks to steadiness every of the three dimensions of ESG with out diluting totally different dimensions of social accountability. With our Social Influence portfolio, we sharpen the give attention to social fairness with partial allocations to gender and racial range centered funds. With our Local weather Influence portfolio, we sharpen the give attention to controlling carbon emissions and fostering inexperienced options.

3. Most accessible SRI-oriented ETFs current liquidity limitations.

Whereas SRI-oriented ETFs have comparatively low expense ratios in comparison with SRI mutual funds, our evaluation revealed inadequate liquidity in lots of ETFs at present available on the market. With out adequate liquidity, each execution turns into dearer, making a drag on returns. Median each day greenback quantity is a method of estimating liquidity. Larger quantity on a given asset means you could shortly purchase (or promote) extra of that asset available in the market with out driving the value up (or down). The diploma to which you’ll be able to drive the value up or down together with your shopping for or promoting have to be handled as a value that may drag down in your returns.

We count on that elevated asset flows throughout the trade into such SRI-oriented ETFs will proceed to drive down expense ratios and enhance liquidity over the long-run. To that finish, Betterment reassesses the funds accessible for inclusion in these portfolios often. In balancing price and worth for the portfolios, the choices are restricted to funds of sure asset lessons reminiscent of US shares, Developed Market shares, Rising Market shares, US Funding Grade Company Bonds, and US Excessive High quality bonds.

How is Betterment’s Broad Influence portfolio constructed?

Betterment’s Broad Influence portfolio invests belongings in socially accountable ETFs to acquire publicity to each the ESG and Shareholder Engagement mandates, as highlighted within the desk above. It focuses on ETFs that think about all three ESG pillars, and contains an allocation to an engagement-based SRI ETF. Broad ESG investing options are at present essentially the most liquid, highlighting their recognition amongst buyers. To be able to preserve geographic and asset class diversification and to fulfill our necessities for decrease price and better liquidity in all SRI portfolios, we proceed to allocate to some funds that don’t replicate SRI mandates, notably in bond asset lessons.

How is Betterment’s Local weather Influence portfolio constructed?

Betterment provides a Local weather Influence portfolio for buyers that wish to put money into an SRI technique extra centered on the environmental pillar of “ESG” moderately than specializing in all ESG dimensions equally. Betterment’s Local weather Influence portfolio invests belongings in socially accountable ETFs and is constructed utilizing the next mandates that search to attain divestment and engagement: ESG, carbon footprint discount, fossil gasoline divestment, shareholder engagement, and inexperienced financing. The Local weather Influence portfolio was designed to present buyers publicity to climate-conscious investments, with out sacrificing correct diversification and balanced price. Fund choice for this portfolio follows the identical pointers established for the Broad Influence portfolio, as we search to include broad primarily based climate-focused ETFs with adequate liquidity relative to their dimension within the portfolio.

How can the Local weather Influence portfolio assist to positively have an effect on local weather change?

The Local weather Influence portfolio is allotted to iShares MSCI ACWI Low Carbon Goal ETF (CRBN), an ETF which seeks to trace the worldwide inventory market, however with a bias in the direction of corporations with a decrease carbon footprint. By investing in CRBN, buyers are actively supporting corporations with a decrease carbon footprint, as a result of CRBN overweights these shares relative to their high-carbon emitting friends. A method we will measure the carbon impression a fund has is by taking a look at its weighted common carbon depth, which measures the weighted common of tons of CO2 emissions per million {dollars} in gross sales, primarily based on the fund’s underlying holdings. Based mostly on weighted common carbon depth knowledge from MSCI, Betterment’s 100% inventory Local weather Influence portfolio has carbon emissions per unit gross sales which can be almost 43% decrease than Betterment’s 100% inventory Core portfolio as of September 30, 2023.

Moreover, a portion of the Local weather Influence portfolio is allotted to fossil gasoline reserve funds. Reasonably than rating and weighting funds primarily based on a sure local weather metric like CRBN, fossil gasoline reserve free funds as a substitute exclude corporations that personal fossil gasoline reserves, outlined as crude oil, pure fuel, and thermal coal. By investing in fossil gasoline reserve free funds, buyers are actively divesting from corporations with a number of the most damaging impression on local weather change, together with oil producers, refineries, and coal miners reminiscent of Chevron, ExxonMobile, BP, and Peabody Vitality.

How is Betterment’s Social Influence portfolio constructed?

Betterment provides a Social Influence portfolio for buyers that wish to put money into a technique extra centered on the social pillar of ESG investing (the S in ESG). Betterment’s Social Influence portfolio invests belongings in socially accountable ETFs and is constructed utilizing the next mandates: ESG, gender fairness, racial fairness, and shareholder engagement. The Social Influence portfolio was designed to present buyers publicity to investments which promote social fairness, with out sacrificing correct diversification and balanced price. Fund choice for this portfolio follows the identical pointers established for the Broad Influence portfolio mentioned above, as we search to include broad primarily based ETFs that concentrate on social fairness with adequate liquidity relative to their dimension within the portfolio.

How does the Social Influence portfolio assist promote social fairness?

The Social Influence portfolio shares lots of the similar holdings as Betterment’s Broad Influence portfolio. The Social Influence portfolio moreover seems to be to additional promote the “social” pillar of ESG investing, by allocating to 2 ETFs that particularly give attention to range and inclusion — Influence Shares NAACP Minority Empowerment ETF (NACP) and SPDR SSGA Gender Range Index ETF (SHE).

NACP is a US inventory ETF supplied by Influence Shares that tracks the Morningstar Minority Empowerment Index. The Nationwide Affiliation for the Development of Coloured Folks (NAACP) has developed a technique for scoring corporations primarily based on plenty of minority empowerment standards. These scores are used to create the Morningstar Minority Empowerment Index, an index which seeks to maximise the minority empowerment rating whereas sustaining market-like threat and robust diversification. The tip result’s an index which offers better publicity to US corporations with robust range insurance policies that empower staff no matter race or nationality. By investing in NACP, buyers are allocating extra of their cash to corporations with a monitor report of social fairness as outlined by the NAACP.

SHE is a US Inventory ETF that enables buyers to put money into extra female-led corporations in comparison with the broader market. To be able to obtain this goal, corporations are ranked inside every sector in response to their ratio of girls in senior management positions. Solely corporations that rank extremely inside every sector are eligible for inclusion within the fund. By investing in SHE, buyers are allocating extra of their cash to corporations which have demonstrated better gender range inside senior management than different companies of their sector.

Conclusion

Regardless of the assorted limitations that every one SRI implementations face at this time, Betterment will proceed to help its prospects in additional aligning their values to their investments. Betterment could add extra socially accountable funds to the SRI portfolios and substitute different ETFs as extra socially accountable merchandise grow to be accessible.