Socially Accountable Investing Portfolios Methodology

Desk of Contents

1. Introduction
2. How will we outline SRI?
3. The Challenges of SRI Portfolio Development
4. How is Betterment’s Broad Influence portfolio constructed?
5. How is Betterment’s Local weather Influence portfolio constructed?
6. How is Betterment’s Social Influence portfolio constructed?
7. Conclusion

Introduction

Betterment launched its first Socially Accountable Investing (SRI) portfolio in 2017, and has widened the funding choices below that umbrella since then. Inside Betterment’s SRI choices, we presently supply a Broad Influence portfolio and two further, extra targeted SRI portfolio choices: a Social Influence SRI portfolio (targeted on social empowerment) and a Local weather Influence SRI portfolio (targeted on climate-conscious investments). These portfolios characterize a diversified, comparatively low-cost resolution constructed utilizing trade traded funds (ETFs), which shall be frequently improved upon as prices decline, extra knowledge emerges, and consequently, the provision of SRI funds broadens.

How will we outline SRI?

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

1. Lowering publicity to investments concerned in unsustainable actions and environmental, social, or governmental controversies.
2. Growing 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 standard identify for the broad idea of values-driven investing (many specialists now favor “sustainable investing” because the identify for the complete class).

Our SRI method makes use of SRI mandates based mostly on a set of trade standards generally known 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 firms to incorporate in, or exclude from, the SRI portfolios. Slightly, Betterment identifies ETFs which have been categorised as ESG or related by third-parties and considers internally developed “SRI mandates” alongside different qualitative and quantitative components to pick out ETFs to incorporate in its SRI portfolios.

Utilizing SRI Mandates

One side of bettering a portfolio’s ESG publicity is lowering publicity to firms 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, army weapons, civilian firearms, in addition to involvement in current and ongoing ESG controversies. Nonetheless, SRI is about extra than simply adjusting your portfolio to reduce firms with a poor social impression.

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 aims 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 choice making is thru shareholder proposals and proxy voting. Publicly traded firms have annual conferences the place they report on the enterprise’s actions to shareholders. As part of these conferences, shareholders can vote on numerous 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 make an express suggestion for the corporate to take a selected plan of action by way of a shareholder proposal.

ETF shareholders themselves don’t vote within the proxy voting strategy of underlying firms, however quite the ETF fund issuer participates within the proxy voting course of on behalf of their shareholders. As buyers sign growing curiosity in ESG engagement, extra ETF fund issuers have emerged that play a extra lively position partaking with underlying firms 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 firms to result in ESG change and permit buyers within the ETF to precise a socially accountable choice. For that reason, Betterment features a Shareholder Engagement Mandate in its SRI portfolios.

The Challenges of SRI Portfolio Development

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

1. Many current SRI choices out there have severe shortcomings.

Many SRI choices at present sacrifice enough diversification acceptable 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 world diversification. According to 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 method to result in ESG-change in company habits. Engagement-based socially accountable ETFs have expressive worth in that they permit buyers to sign their curiosity in ESG points to firms 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 buyers who prioritize an absolute exclusion of particular sorts of firms 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 embrace some power firms that have interaction in oil and pure gasoline exploration, like Hess. Whereas Hess may not 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 want to focus particularly on a sure pillar of ESG, Betterment has made three SRI portfolios out there. The Broad Influence portfolio seeks to stability every of the three dimensions of ESG with out diluting totally different dimensions of social duty. With our Social Influence portfolio, we sharpen the concentrate on social fairness with partial allocations to gender and racial range targeted funds. With our Local weather Influence portfolio, we sharpen the concentrate on controlling carbon emissions and fostering inexperienced options.

3. Most out there 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 enough liquidity, each execution turns into costlier, making a drag on returns. Median day by day greenback quantity is a technique of estimating liquidity. Increased quantity on a given asset means that you could shortly purchase (or promote) extra of that asset out there 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 should 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 improve liquidity over the long-run. To that finish, Betterment reassesses the funds out there for inclusion in these portfolios often. 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, US Excessive High quality bonds, and US Mortgage-Backed Securities.

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 take into account all three ESG pillars, and consists of an allocation to an engagement-based SRI ETF. Broad ESG investing options are presently probably the most liquid, highlighting their recognition amongst buyers. With a purpose to keep 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, significantly in bond asset lessons.

How is Betterment’s Local weather Influence portfolio constructed?

Betterment gives a Local weather Influence portfolio for buyers that wish to spend money on an SRI technique extra targeted on the environmental pillar of “ESG” quite 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 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 based mostly climate-focused ETFs with enough 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 direction of firms with a decrease carbon footprint. By investing in CRBN, buyers are actively supporting firms 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, based mostly 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 are greater than 40% decrease than Betterment’s 100% inventory Core portfolio as of October 22, 2024.

Moreover, a portion of the Local weather Influence portfolio is allotted to fossil gasoline reserve funds. Slightly than rating and weighting funds based mostly on a sure local weather metric like CRBN, fossil gasoline reserve free funds as an alternative exclude firms that personal fossil gasoline reserves, outlined as crude oil, pure gasoline, and thermal coal. By investing in fossil gasoline reserve free funds, buyers are actively divesting from firms with among the most adverse impression on local weather change, together with oil producers, refineries, and coal miners resembling Chevron, ExxonMobile, BP, and Peabody Power.

One other approach that the Local weather Influence portfolio promotes a optimistic environmental impression is by investing in bonds that fund inexperienced tasks. The Local weather Influence portfolio invests in iShares International Inexperienced Bond ETF (BGRN), which tracks the worldwide market of investment-grade bonds linked to environmentally helpful tasks, as decided by MSCI. These bonds are referred to as “inexperienced bonds.” The inexperienced bonds held by BGRN fund tasks in numerous environmental classes outlined by MSCI together with various power, power effectivity, air pollution prevention and management, sustainable water, inexperienced constructing, and local weather adaptation.

How is Betterment’s Social Influence portfolio constructed?

Betterment gives a Social Influence portfolio for buyers that wish to spend money on a technique 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, social fairness, and shareholder engagement. The Social Influence portfolio was designed to present buyers publicity to investments which promote social empowerment 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 based mostly ETFs that target social empowerment with enough liquidity relative to their measurement within the portfolio.

How does the Social Influence portfolio assist promote social empowerment?

The Social Influence portfolio shares most of the identical 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 the next ETFs:

• Influence Shares NAACP Minority Empowerment ETF (NACP)
• SPDR SSGA Gender Range Index ETF (SHE)
• Academy Veteran Influence ETF(VETZ)
• Goldman Sachs JUST U.S. Giant Cap Fairness ETF (JUST)

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 firms based mostly on numerous 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 gives better publicity to US firms with sturdy range insurance policies that empower workers regardless of race or nationality. By investing in NACP, buyers are allocating extra of their cash to firms with a monitor file of social fairness as outlined by the NAACP.

SHE is a US Inventory ETF that enables buyers to spend money on extra female-led firms in comparison with the broader market. With a purpose to obtain this goal, firms are ranked inside every sector in line with their ratio of ladies in senior management positions. Solely firms 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 firms which have demonstrated better gender range inside senior management than different corporations of their sector.

VETZ, the Academy Veteran Influence ETF, is a US Bond ETF and is the primary publicly traded ETF to primarily spend money on loans to U.S. service members, army veterans, their survivors, and veteran-owned companies. A majority of the underlying property encompass loans to veterans or their households. The fund primarily invests in Mortgage-Backed Securities which are assured by government-sponsored enterprises, resembling Ginnie Mae, Fannie Mae, and Freddie Mac. The fund additionally invests in swimming pools of small enterprise loans backed by the Small Enterprise Administration (SBA).

JUST, Goldman Sachs JUST U.S. Giant Cap Fairness ETF, invests in U.S. firms selling optimistic change on key social points, resembling employee wellbeing, buyer privateness, environmental impression, and group energy, based mostly on the values of the American public as recognized by JUST Capital’s polling.

Funding in socially accountable ETFs varies by portfolio allocation; not all allocations embrace the precise ETFs listed above. For extra details about these social impression ETFs, together with any related dangers, please see our disclosures.

Ought to we count on any distinction in an SRI portfolio’s efficiency?

One may count on {that a} socially accountable portfolio may result in decrease returns in the long run in comparison with one other, related portfolio. The notion behind this reasoning is that by some means there’s a premium to be paid for investing based mostly in your social beliefs and values.

A white paper written in partnership between Rockefeller Asset Administration and NYU Stern Middle for Sustainable Enterprise studied 1,000+ analysis papers printed from 2015 to 2020 analyzing the connection between ESG investing and efficiency. The first takeaway from this analysis was that they discovered “optimistic correlations between ESG efficiency and operational efficiencies, inventory efficiency, and decrease price of capital.” When ESG components have been thought-about within the research, there appeared to be improved efficiency potential over longer time durations and potential to additionally present draw back safety during times of disaster. It’s essential to notice that efficiency within the SRI portfolios will be impacted by a number of variables, and isn’t assured to align with the outcomes of this research.

Dividend Yields Might Be Decrease

Utilizing the SRI Broad Influence portfolio for reference, dividend yields over a one-year interval ending October 31, 2024 point out that SRI earnings returns at sure threat ranges have been decrease than these of the Core portfolio. Oil and gasoline firms like BP, Chevron, and Exxon, for instance, presently have comparatively excessive dividend yields, and excluding them from a given portfolio could cause its earnings return to be decrease. After all, future dividend yields are unsure variables and previous knowledge could not present correct forecasts. However, decrease dividend yields could be a consider driving whole returns for SRI portfolios to be decrease than these of Core portfolios.

Comparability of Dividend Yields

Supply: Bloomberg, Calculations by Betterment for one yr interval ending October 31, 2024. Dividend yields for every portfolio are calculated utilizing the dividend yields of the first ETFs used for taxable allocations of Betterment’s portfolios as of October 2024.

Conclusion

Regardless of the varied limitations that every one SRI implementations face at present, Betterment will proceed to assist its clients in additional aligning their values to their investments. Betterment could add further socially accountable funds to the SRI portfolios and change different ETFs as extra socially accountable merchandise turn into out there.