Socially Accountable Investing Portfolios Methodology

Introduction

Betterment launched its first Socially Accountable Investing (SRI) portfolio in 2017, and has widened the funding choices underneath that umbrella since then. Inside Betterment’s SRI choices, we at present provide a Broad Affect portfolio and two further, extra centered SRI portfolio choices: a Social Affect SRI portfolio (centered on social empowerment) and a Local weather Affect SRI portfolio (centered on climate-conscious investments). These portfolios symbolize a diversified, comparatively low-cost resolution constructed utilizing change traded funds (ETFs), which might be frequently improved upon as prices decline, extra knowledge emerges, and in consequence, 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. 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, equivalent to shareholder proposals and proxy voting, to incentivize socially accountable company habits.

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

Our SRI method makes use of SRI mandates based mostly on a set of business standards often called “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 instantly choose firms to incorporate in, or exclude from, the SRI portfolios. Quite, Betterment identifies ETFs which have been categorized as ESG or comparable 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 facet of enhancing a portfolio’s ESG publicity is decreasing publicity to firms that interact in sure actions which may be thought-about undesirable as a result of they don’t align with particular values. These actions might embrace promoting tobacco, navy weapons, civilian firearms, in addition to involvement in current and ongoing ESG controversies. Nevertheless, 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 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. One of the crucial direct methods a shareholder can affect an organization’s resolution 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 quite a few subjects equivalent to 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 way of a proxy card. A shareholder may make an express 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 strategy of underlying firms, however fairly 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 energetic function partaking with underlying firms by way of proxy voting to advocate for extra socially accountable company practices. These issuers use engagement-based methods, equivalent to shareholder proposals and director nominees, to have interaction with firms to result in ESG change and permit buyers within the ETF to specific a socially accountable desire. 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 present SRI choices available in the market have severe shortcomings.

Many SRI choices immediately 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. According to our core precept of world 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 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 specific shareholder campaigns are unsuccessful.

2. Integrating values into an ETF portfolio might not at all times meet each investor’s expectations.

For buyers who prioritize an absolute exclusion of particular kinds of firms 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 firms that interact 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 might favor to focus particularly on a sure pillar of ESG, Betterment has made three SRI portfolios out there. The Broad Affect portfolio seeks to stability every of the three dimensions of ESG with out diluting completely different dimensions of social duty. With our Social Affect portfolio, we sharpen the give attention to social fairness with partial allocations to gender and racial variety centered funds. With our Local weather Affect portfolio, we sharpen the give attention to 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 at present in the marketplace. With out adequate liquidity, each execution turns into costlier, making a drag on returns. Median day by day greenback quantity is a technique of estimating liquidity. Greater quantity on a given asset means that you would be able to rapidly 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 drive the value up or down together with your shopping for or promoting have to be handled as a price 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 improve liquidity over the long-run. To that finish, Betterment reassesses the funds out there for inclusion in these portfolios frequently. In balancing price and worth for the portfolios, the choices are restricted to funds of sure asset lessons equivalent to 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 Affect portfolio constructed?

Betterment’s Broad Affect 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 take into account 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 reputation amongst buyers. With the intention to keep geographic and asset class diversification and to satisfy 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, notably in bond asset lessons.

How is Betterment’s Local weather Affect portfolio constructed?

Betterment provides a Local weather Affect portfolio for buyers that need to put money into an SRI technique extra centered on the environmental pillar of “ESG” fairly than specializing in all ESG dimensions equally. Betterment’s Local weather Affect portfolio invests belongings 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 Affect portfolio was designed to offer 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 Affect portfolio, as we search to include broad based mostly climate-focused ETFs with adequate liquidity relative to their measurement within the portfolio.

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

The Local weather Affect 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 technique we are able to 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 Affect portfolio has carbon emissions per unit gross sales which can be greater than 40% decrease than Betterment’s 100% inventory Core portfolio as of October 22, 2024.

Moreover, a portion of the Local weather Affect portfolio is allotted to fossil gasoline reserve funds. Quite than rating and weighting funds based mostly on a sure local weather metric like CRBN, fossil gasoline reserve free funds as a substitute 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 unfavorable impression on local weather change, together with oil producers, refineries, and coal miners equivalent to Chevron, ExxonMobile, BP, and Peabody Power.

How is Betterment’s Social Affect portfolio constructed?

Betterment provides a Social Affect portfolio for buyers that need to put money into a technique extra centered on the social pillar of ESG investing (the S in ESG).
Betterment’s Social Affect portfolio invests belongings in socially accountable ETFs and is constructed utilizing the next mandates: ESG, gender fairness, racial fairness, social fairness, and shareholder engagement. The Social Affect portfolio was designed to offer 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 Affect portfolio mentioned above, as we search to include broad based mostly ETFs that concentrate on social empowerment with adequate liquidity relative to their measurement within the portfolio.

How does the Social Affect portfolio assist promote social empowerment?

The Social Affect portfolio shares lots of the similar holdings as Betterment’s Broad Affect portfolio. The Social Affect portfolio moreover appears to be like to additional promote the “social” pillar of ESG investing by allocating to the next ETFs:

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

NACP is a US inventory ETF supplied by Affect Shares that tracks the Morningstar Minority Empowerment Index. The Nationwide Affiliation for the Development of Coloured Individuals (NAACP) has developed a technique for scoring firms based mostly on quite a few 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 tip result’s an index which gives larger publicity to US firms with sturdy variety insurance policies that empower staff no matter race or nationality. By investing in NACP, buyers are allocating extra of their cash to firms with a observe file of social fairness as outlined by the NAACP.

SHE is a US Inventory ETF that permits buyers to put money into extra female-led firms in comparison with the broader market. With the intention to obtain this goal, firms are ranked inside every sector based on their ratio of girls 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 larger gender variety inside senior management than different corporations of their sector.

VETZ, the Academy Veteran Affect ETF, is a US Bond ETF and is the primary publicly traded ETF to primarily put money into loans to U.S. service members, navy veterans, their survivors, and veteran-owned companies. A majority of the underlying belongings include loans to veterans or their households. The fund primarily invests in Mortgage-Backed Securities which can be assured by government-sponsored enterprises, equivalent to 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. Massive Cap Fairness ETF, invests in U.S. firms selling optimistic change on key social points, equivalent to 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.

Conclusion

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