Some investors wish to align their personal values with their investment portfolio, but there have traditionally been several stumbling blocks for investors looking to assemble a diversified ESG (Environmental, Social, and Governance) portfolio.
Fortunately, WrapManager now offers an innovative ESG investment solution which seeks to provide diversification among asset classes, market capitalization, country of domicile, and ESG methodology.
What are ESG criteria? Environmental, Social, and Governance (ESG) criteria is a set of standards for company’s operations that socially conscious investors can use to screen investments. Environmental criteria look at how a company performs as a steward of the natural environment. Social criteria examine how a company manages relationships with its employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
Historically Speaking ESG Investment Trends and Options Were Limited
DIY ESG Portfolios
A do-it-yourself investor may wish to build their own portfolio of ESG friendly companies. This can be a very labor-intensive undertaking, however, since there is a lot of research required to select stocks from a universe that includes thousands of different options. A typical do-it-yourself investor may invest a great deal of time in assembling an ESG portfolio composed of well-known, domestic large-cap ESG friendly companies only to build out a portfolio that is poorly diversified.
Another approach to ESG investing that a do-it-yourself investor may employ is to only purchase investments in a single industry such as solar power. Once again, an investor with such a narrow focus will suffer from a poorly diversified portfolio. Moreover, a niche industry such as solar power can have extremely volatile returns.
ESG Mutual Funds
Alternatively, an investor may have looked to purchase an ESG focused mutual fund or ETF instead of picking individual stocks for their own portfolio. While this saves the investor the time and effort of researching thousands of stocks, the investor can be left with a poorly diversified portfolio that is very large-cap heavy since there are very few ESG focused ETFs that are specific to small-cap and mid-cap companies.
Many ESG focused mutual funds and ETFs focus exclusively on domestic large cap stocks. Once again, the investor is left with no exposure (or maybe minimal exposure) to small cap, mid cap, and non-US companies.
Also, the approach to ESG investing for some ESG mutual funds or ETFs is to simply exclude select industries such as oil and tobacco. While there is nothing wrong with this simplistic negative screening approach, it can potentially lead to a large performance disparity compared to a broad benchmark if dozens or even hundreds of companies are always excluded. Also, an approach that simply excludes certain industries may allow non-ESG friendly companies into the portfolio.
For example, a company with poor data security and/or ineffective personal privacy safeguards probably shouldn’t be considered a “socially responsible” company simply because the company doesn’t sell oil or tobacco.
ESG Investment Indexes – Positive vs. Negative Screenings
There are ESG solutions that provide positive screening rather than negative screening. In other words, the portfolio will seek to include the most ESG-friendly companies, rather than simply exclude companies in select industries.
Based on the framework created by MSCI (an index and analytics provider) ESG is more quantifiable than ever.
MSCI offers ESG ratings on publicly traded companies based on their proprietary ESG rating methodology. MSCI will evaluate several ESG factors including governance issues such as board make-up, corporate behavior, and business ethics, social issues such as product safety, health and safety standards, and privacy and data security, and environmental issues such as carbon emissions, energy efficiency, and biodiversity and land use. MSCI then gives each company an overall ESG score ranging from “AAA” (the highest ESG rating) to “CCC” (the lowest ESG rating).
Many ESG ETF providers use these ESG metrics from MSCI to construct their portfolios.
Introducing the SAIRSHA Global All Cap ESG Portfolio
The WrapManager Strategically Aligned Investments Rooted in Social and Humanitarian Advancement (SAIRSHA) Global All Cap ESG portfolio seeks to offer a solution to the traditional pitfalls of investing in socially responsible portfolios.
The SAIRSHA Global All Cap ESG portfolio is a reflection of one of the core principles of investing: it is broadly diversified with exposure to small cap, mid cap, non-US developed market companies, and emerging markets companies. The portfolio uses asset class specific ETFs to gain exposure to each of these asset classes.
The SAIRSHA portfolio also integrates multiple ESG methodologies into one portfolio.
Some of the ETF investments in the portfolio offer exclusionary screenings which filter out companies in unfriendly businesses such as fossil fuels, tobacco, and weapons. Other ETF investments in the portfolio offer positive screening where companies with the strongest ESG ratings are included in the portfolio. Lastly, there are industry specific ETFs in the portfolio which cover clean energy such as solar and wind energy. These niche industry ETFs only make up a small percentage of the portfolio because of the potential for volatile returns for those industries.
What are the ESG principles?
WrapManager’s approach to ESG investing can potentially create some oddities. The SAIRSHA portfolio may include exposure to oil and natural gas companies, for example. An oil and natural gas company may score poorly on environmental factors but may score very highly in social and governance factors. Likewise, a company that is very environmentally friendly may have a low weighting in the portfolio (or be excluded altogether) because it scores poorly in social or governance factors.
An investor with a singular focus on excluding a particular industry (like tobacco, for example) may seek to use a traditional separately managed account coupled with security restrictions to exclude all of the tickers in the particular industry in order to achieve their goal of not having any exposure to the tobacco industry.
While there is no perfect answer for every single investor who seeks to align their investment portfolio with their values, WrapManager now offers an innovative approach to building broadly diversified ESG portfolios. Investors shouldn’t have to settle for a traditional approach to ESG investing which can be plagued by poor diversification.
Socially responsible investing is qualitative and subjective by nature, and there is no guarantee that the criteria utilized, or judgement exercised by WrapManager or the underlying ETF companies will reflect the beliefs or values of any one particular investor. Information regarding responsible practices is obtained through voluntary or third-party reporting, which may not be accurate or complete and WrapManager is dependent on such information to evaluate a company’s commitment to, or implementation of, responsible practices. Socially responsible norms vary by region. There is no assurance that the socially responsible investing strategy and techniques employed will be successful.
Diversification does not ensure a profit and may not protect against loss in declining markets. Past performance is not a guarantee or reliable indicator of future results. All investments contain risk and may lose value.
Exchange Traded Funds (ETFs) are subject to market risk, including the possible loss of principal. The value of the portfolio will fluctuate with the value of the underlying securities. ETFs may trade for less than their net asset value. Investors should consider an ETF's investment objective, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other important information, is available from your Financial Advisor and should be read carefully before investing. ETFs may have underlying investment strategy risks similar to investing in commodities, bonds, real estate, international markets or currencies, emerging growth companies, or specific sectors.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
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Strategy descriptions listed represent a brief outline of the portfolio’s objective. There is no guarantee that any manager or product will be successful in achieving the objective described. The strategy or strategies described herein are not suitable for all investors. This material does not represent a personalized recommendation and does not reflect individual investor’s risk and return goals nor does it serve as the receipt of, or a substitute for, personalized advice from WrapManager, Inc. or any other investment professional. Prior to selecting an investment option, it is important you discuss the manager with your financial advisor. Your financial advisor can help you determine proper suitability constraints and objectives as determined from your individual needs and circumstances.
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