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 presently provide a Broad Influence portfolio and two extra, extra targeted SRI portfolio choices: a Social Influence SRI portfolio (targeted on social governance mandates) and a Local weather Influence SRI portfolio (targeted on climate-conscious investments). These portfolios symbolize a diversified, comparatively low-cost answer constructed utilizing trade traded funds (ETFs), which will probably be frequently improved upon as prices decline, extra information emerges, and consequently, the supply of SRI funds broadens.

How will we outline SRI?

Our method to SRI has three basic dimensions that form our portfolio building mandates:

1. Lowering 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, resembling shareholder proposals and proxy voting, to incentivize socially accountable company habits.

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

Our SRI method makes use of SRI mandates primarily based on a set of business 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 method expands upon the ESG-investing framework with publicity to investments that use complementary shareholder engagement instruments.

Betterment doesn’t immediately choose corporations to incorporate in, or exclude from, the SRI portfolios. Slightly, Betterment identifies ETFs which have been labeled as ESG or related by third-parties and considers internally developed “SRI mandates” alongside different qualitative and quantitative components to pick ETFs to incorporate in its SRI portfolios.

Utilizing SRI Mandates

One side of bettering a portfolio’s ESG publicity is lowering publicity to corporations that interact in sure actions which may be thought-about undesirable as a result of they don’t align with particular values. These actions could embody 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 attenuate corporations with a poor social affect.

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

Shareholder Engagement Mandate

Along with the mandates listed above, Betterment’s SRI portfolios are constructed utilizing a shareholder engagement mandate. One of the direct methods a shareholder can affect an organization’s choice 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 a lot of subjects resembling share possession, the composition of the board of administrators, and government 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 way of a proxy card. A shareholder may also make an specific suggestion for the corporate to take a particular plan of action by way of a shareholder proposal.

ETF shareholders themselves don’t vote within the proxy voting technique of underlying corporations, however moderately the ETF fund issuer participates within the proxy voting course of on behalf of their shareholders. As traders sign growing curiosity in ESG engagement, extra ETF fund issuers have emerged that play a extra lively function partaking with underlying corporations by way of proxy voting to advocate for extra socially accountable company practices. These issuers use engagement-based methods, resembling shareholder proposals and director nominees, to have interaction with corporations to result in ESG change and permit traders within the ETF to specific a socially accountable choice. 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 total method to constructing an SRI portfolio:

1. Many present SRI choices out there have critical shortcomings.

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

Betterment’s SRI portfolios don’t sacrifice world diversification. In line with 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 embody a partial allocation to an engagement-based socially accountable ETF utilizing shareholder advocacy as a way to result in ESG-change in company habits. Engagement-based socially accountable ETFs have expressive worth in that they permit traders 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 at all times meet each investor’s expectations.

For traders who prioritize an absolute exclusion of particular kinds of corporations above all else, sure approaches to ESG will inevitably fall wanting expectations. For instance, most of the largest ESG funds targeted on US Giant Cap shares embody some power corporations that interact 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 traders could favor to focus particularly on a sure pillar of ESG, Betterment has made three SRI portfolios accessible. The Broad Influence portfolio seeks to stability every of the three dimensions of ESG with out diluting completely different dimensions of social accountability. With our Social Influence portfolio, we sharpen the deal with social fairness with partial allocations to gender and racial variety targeted funds. With our Local weather Influence portfolio, we sharpen the deal with 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 presently in the marketplace. With out ample 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 out there with out driving the worth up (or down). The diploma to which you’ll be able to drive the worth up or down along with your shopping for or promoting should be handled as a value that may drag down in your returns.

We anticipate that elevated asset flows throughout the business 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 frequently. In balancing price and worth for the portfolios, the choices are restricted to funds of sure asset lessons resembling 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 property 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 presently essentially the most liquid, highlighting their reputation amongst traders. With a purpose 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 mirror SRI mandates, significantly in bond asset lessons.

How is Betterment’s Local weather Influence portfolio constructed?

Betterment affords a Local weather Influence portfolio for traders that need to put money into an SRI technique extra targeted on the environmental pillar of “ESG” moderately than specializing in all ESG dimensions equally. Betterment’s Local weather Influence portfolio invests property in socially accountable ETFs and is constructed utilizing the next mandates that search to realize divestment and engagement: ESG, carbon footprint discount, fossil gasoline divestment, shareholder engagement, and inexperienced financing. The Local weather Influence portfolio was designed to present traders publicity to climate-conscious investments, with out sacrificing correct diversification and balanced price. Fund choice for this portfolio follows the identical tips established for the Broad Influence portfolio, as we search to include broad primarily based climate-focused ETFs with ample liquidity relative to their measurement 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, traders 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 technique we are able to measure the carbon affect 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 information from MSCI, Betterment’s 100% inventory Local weather Influence portfolio has carbon emissions per unit gross sales which can be almost 50% decrease than Betterment’s 100% inventory Core portfolio as of February 8, 2024.

Moreover, a portion of the Local weather Influence portfolio is allotted to fossil gasoline reserve funds. Slightly 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, traders are actively divesting from corporations with a number of the most damaging affect on local weather change, together with oil producers, refineries, and coal miners resembling Chevron, ExxonMobile, BP, and Peabody Vitality.

How is Betterment’s Social Influence portfolio constructed?

Betterment affords a Social Influence portfolio for traders that need to put money into a method extra targeted on the social pillar of ESG investing (the S in ESG). Betterment’s Social Influence portfolio invests property 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 traders publicity to investments which promote social fairness, with out sacrificing correct diversification and balanced price. Fund choice for this portfolio follows the identical tips established for the Broad Influence portfolio mentioned above, as we search to include broad primarily based ETFs that target social fairness with ample liquidity relative to their measurement within the portfolio.

How does the Social Influence portfolio assist promote social fairness?

The Social Influence portfolio shares most of the similar holdings as Betterment’s Broad Influence portfolio. The Social Influence portfolio moreover appears to additional promote the “social” pillar of ESG investing, by allocating to 2 ETFs that particularly deal with variety 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 strategy for scoring corporations primarily based on a lot 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 powerful diversification. The top result’s an index which offers higher publicity to US corporations with sturdy variety insurance policies that empower staff no matter race or nationality. By investing in NACP, traders are allocating extra of their cash to corporations with a observe document of social fairness as outlined by the NAACP.

SHE is a US Inventory ETF that permits traders to put money into extra female-led corporations in comparison with the broader market. With a purpose to obtain this goal, corporations are ranked inside every sector in line with their ratio of ladies in senior management positions. Solely corporations that rank extremely inside every sector are eligible for inclusion within the fund. By investing in SHE, traders are allocating extra of their cash to corporations which have demonstrated higher gender variety inside senior management than different companies of their sector.

Conclusion

Regardless of the varied limitations that each one SRI implementations face right this moment, Betterment will proceed to assist 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 change into accessible.