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Investing with Purpose

ESGESG and SRI Investing

Investors use Environmental, Social, and Governance (ESG) criteria to guide more sustainable and socially responsible investment. ESG falls under the umbrella of socially responsible investing, or SRI. SRI is any investment strategy that considers both financial returns and social and environmental impacts when evaluating the suitability of investments.

Incorporation of ESG criteria helps asset owners align investment decisions to their values and beliefs. It facilitates investing with purpose. ESG links health and wealth outcomes, highlighting the interdependence of healthy populations, environments, and economies.

Environmental criteria address issues like climate change, pollution reduction, and sustainable utilization of natural resources. They increase pressure for regulations that establish environmental liability and steer markets towards sustainable products and services. The criteria also help evaluate practices like greenhouse gas emissions, water usage, and waste disposal. Furthermore, they encourage companies to exhibit transparency surrounding these practices.

Social criteria look at how a company interacts with employees, suppliers, customers, and communities. It addresses workplace health and safety, discriminatory practices, diversity, human rights issues, and again, transparency about these practices.

Governance criteria assess company leadership, board structure and diversity, executive pay, audits, internal controls, and shareholder rights. It evaluates accounting and disclosure practices and controls to prevent corruption and bribery issues.

The more sustainable a company, the higher its ESG score. Investment strategies that integrate ESG criteria into portfolios decrease the weight of companies with lower ESG scores and increase the weight of companies with higher ESG scores. Third parties evaluate company disclosures to subjectively generate these scores.

Several ESG ratings firms now exist to assess and score the ESG disclosures, such as Sustainalytics (with an ownership stake by Morningstar), Institutional Shareholder Services, and MSCI. Think of these as the Moody’s and Standard and Poor’s for sustainability.

Types of Sustainable Investing

ESG integration is one of the most common types of sustainable investment strategies. Restriction screening is also very popular, eliminating industries like tobacco, weaponry, or environmentally damaging operations. Morgan Stanley defined five types of sustainable investing or SRI:

  • ESG Integration – Proactively considering ESG criteria alongside financial analysis.
    Restriction Screening – Exclusionary, negative or values-based screening of investments.
  • Impact Investing – Seeking to make investments that intentionally generate measurable positive social and/or environmental outcomes.
  • Thematic Investing – Pursuing strategies that address sustainability trends such as clean energy, water, agriculture or community development.
  • Shareholder Engagement – Direct company engagement or activist approaches.

The Rise of Socially Responsible Investing

Amy Domini is known as the godmother of socially responsible investing. She started the SRI movement in the 1990s and made the Time 100 list of the world’s most influential people in 2005. She said, “We must continue to stand together to demand that the search for monetary profits not come at the detriment of universal human dignity nor the undermining of ecological sustainability.”

The emergence of the term “ESG” traces back to a 2004 report by the Global Compact titled “Who Cares Wins.” It was published in response to growing investor demand for more sustainable investment avenues and laid the foundations for a common understanding of ESG investment criteria.

The report stated a belief that markets did not fully recognize the significance of emerging trends pressuring companies to improve corporate governance, transparency and accountability, nor the high stakes of reputational risks related to ESG issues.

It emphasized the long-term importance of sustainable development, saying, “A better inclusion of environmental, social and corporate governance (ESG) factors in investment decisions will ultimately contribute to more stable and predictable markets, which is in the interest of all market actors.”

The incorporation of ESG principles and the practice of SRI have exploded in popularity. In 2017, 48% of retail and institutional investors worldwide applied ESG principles to at least a quarter of their portfolios. By 2019, that percentage surged to 75%. The European Union (“EU”) holds the most sustainable invested assets at $14.1 trillion US dollar (USD) equivalents. The United States follows with $12 trillion USD of sustainably invested assets.

SRI now accounts for one out of every four dollars under professional management in the United States. In Europe, it accounts for one out of every two dollars. Sustainable investing is often a voluntary and strategic venture motivated by constituent demand, perceived potential for attractive financial performance, and evolving regulations driving greater disclosure on ESG factors.

Client demand from retail and institutional investors is the top reason for the incorporation of ESG factors in financial reporting disclosures. In the United States, corporations that provide ESG disclosures do so voluntarily. Unlike the EU, there is no definitive accounting or financial reporting framework in the U.S. under which ESG factors are measured and reported to stakeholders.

ESG is most popular among millennials, women, and high-net-worth individuals. 95% of millennials surveyed by Morgan Stanley in 2019 expressed interest in sustainable investing and 90% want to tailor their investments to their impact goals derived from personal values and beliefs.

Millennials are poised to inherit over $68 trillion from their predecessors by 2030. Accordingly, the millennial ‘approach to investing’ will be an important determinant in the demand for ESG investments going forward.

The Deloitte Center for Financial Services (DCFS) projects client demand will accelerate ESG-mandated asset growth by three times that of non-ESG-mandated assets to comprise half of all professionally managed investments in the United States by 2025. Investment managers will likely respond to client demand for ESG by launching new ESG funds.


The iShares ESG MSCI U.S.A. ETF (ESGU) launched in 2016 is the largest Socially Responsible ETF, with $7.8 billion in assets under management. ESGU tracks the MSCI USA Extended ESG Focus Index.

The index functions to maximize exposure to positive environmental, social and governance (ESG) factors. MSCI’s ESG rating framework determines these factors. Additionally, the index exhibits risk and return characteristics similar to those of the MSCI USA Index.

The MSCI USA Extended ESG Focus Index is sector-diversified and targets companies with high ESG ratings in each sector. It excludes tobacco and firearms manufacturers. iShares MSCI KLD 400 Social ETF (DSI) based on Domini’s groundbreaking work in socially responsible investing was the largest ETF prior to the launch of ESGU by BlackRock.

By February 2020, the number of ESG ETFs had skyrocketed to 293, with 805 listings globally. According to ETFGI, total assets invested globally in ESG ETFs reached a new record of $82 billion at the end of May 2020. There are currently 108 socially responsible ETFs traded in the U.S. markets, gathering total assets under management at a value of $37.2 billion and an average expense ratio of 0.39%.

Several brand-name U.S. mega-cap companies are seizing opportunities to incorporate ESG into their governance frameworks. As a result, they will demonstrate their commitment to sustainability to shareholders, stakeholders and customers.

This year, Microsoft pledged to be carbon negative by 2030. By 2050, they aim to remove all the carbon emitted either directly or from electrical consumption since their founding in 1975. This carbon negative goal will be achieved through a $1 billion climate innovation fund to accelerate the global development of carbon reduction, capture, and removal technologies.

By contrast, Starbucks has less ambitious (yet more attainable) sustainability goals. By 2030, the company will reduce carbon emissions by 50 percent. They will also reduce waste sent to landfills from stores and manufacturing by 50 percent. Finally, they will conserve or replenish 50 percent of the water currently used for direct operations and coffee production.

ESG Impact on Expected Returns

Many investors express concern that ESG investing will limit their investment options and potentially lead to lower returns. Studies and analyses express varying conclusions regarding whether ESG investing helps or hurts overall portfolio performance. There is a lively theoretical and practical debate.

In this video, Ben Felix from PWL Capital provides important insights to consider before committing to a sustainable portfolio, based on the assertion that sustainable portfolios provide lower expected returns.

Felix discusses the impact of socially responsible investing on expected returns according to a December 2019 study written. After analyzing a global sample of 5,972 firms between 2004-2018, the authors concluded that companies with higher ESG scores tended to deliver lower average returns than companies with lower ESG scores.

Investor tastes and preferences contribute to pricing effects on expected returns of sustainable and unsustainable companies. Investors with a strong preference for sustainable investments are less likely to invest in unsustainable companies that don’t reflect their core values and beliefs. They are more likely to invest in sustainable companies with lower returns for the tradeoff of aligning investment to their values.

Another implication of this tradeoff is that sustainably-minded investors will require higher expected returns to consider investing in an unsustainable company; the opportunity for financial gain would have to overshadow their desire to uphold a socially responsible portfolio.

At the other end of the spectrum, The Harvard Business School conducted a study in May 2019 that found companies adopting sustainability practices outperform their competitors. According to their analysis, a $1 investment over 20 years yielded $28 in return for companies focused on ESG factors versus a $14 yield for companies without focus on ESG factors. So rather than sustainable portfolios providing lower returns, Harvard concluded that ESG factors enhanced returns.

Research Affiliates, a global investment research firm, recently weighed in on whether ESG integration contributed to portfolio performance in their report, “Is ESG a Factor?” Factors are stock characteristics associated with a long-term risk-adjusted return premium.

In other words, an investor can systematically employ a factor to enhance portfolio returns. Factors must satisfy three critical requirements: they should be grounded in credible academic literature, consistent across definitions, and robust across geographies.

Research Affiliates concluded ESG was not a factor because there is little agreement in academic literature regarding its robustness in earning a return premium for investors, it lacks a common standard definition, and its performance results are not robust across geographies. They believe ESG is an important investing consideration despite dismissing it as a factor and lacking complete confidence in its ability to currently deliver as a theme.

One of our core investment beliefs is that investor preferences are broader than risk and return. Nevertheless, ESG can be a very powerful theme in the portfolio management process in the years ahead. However, as noted by Research Affiliates in their ESG factor analysis, one of the fundamental issues with ESG integration is that there is no common framework for evaluating companies’ ESG impacts.



Call to Action

In his upcoming book, “Impact: Reshaping Capitalism To Drive Real Change”, Sir Ronald Cohen boldly addresses the obstacle of a lack of a common ESG impact measurement and assessment framework. He proposes the international adoption of “generally accepted impact principles” to transparently and consistently reflect the measurement of ESG impacts in financial statements to display “impact weighted profits.”

Cohen argues that today’s technology and big data allow us to reliably measure and assess impacts. He recommends that if governments force companies to publish impact weighted accounts, companies and stakeholders will develop a sharper focus on improving their impact and find creative solutions to social and environmental problems. Cohen calls this novel approach impact capitalism.

Impact capitalism is the invisible heart of markets that drives the invisible hand of Adam Smith’s Wealth of Nations. Impact is the third essential dimension to consider alongside risk and return when considering possible investments. Connecting social initiatives to investment criteria in this manner will enable entrepreneurs to finance purpose-driven investment and charitable organizations.

Investments are deemed attractive when their risk-reward potential is favorable. However, some investments have hidden costs that negatively impact employees, surrounding communities, or the environment.

Many companies do not factor in the cost of mitigating social and environmental problems caused by their operations in their traditional investment analysis, such as a factory that emits air pollution and afflicts people in the area with respiratory problems. These unpaid costs are also known as externalities – costs that are often incurred by vulnerable populations that don’t have the means to fix the problem themselves.

Impact investing presents an opportunity to take the pain out of profit. Its framework fosters financial success that is both self-interested and societally beneficial. When positive impact and profit coexist, everyone wins.

We think impact capitalism has the potential to drive creative solutions for the many socioeconomic imbalances and environmental issues we face today. Watch for our upcoming digital series that will explore these critical matters in greater depth.

Wake Up to Bitcoin

What is Bitcoin and how does it work?
Bitcoin (BTC) is the most well-known and successful form of cryptocurrency with a market capitalization of about $170 billion at $9,300 per BTC and daily trading volume of $700 million.  It is especially popular among tech-savvy millennials who find it appealing for investment.  According to a nationwide survey by Bankrate in July 2019, millennials are three times more likely to invest in crypto than Generation X.  Bitcoin is the brand-name category killer and the Amazon of the digitally networked crypto world. 

Bitcoin is a digital and decentralized cryptocurrency built on blockchain technology. Blockchain architecture is designed to address concerns like decentralization, privacy, identity, trust and ownership of data. Blockchain’s democratized model uses distributed data storage, peer-to-peer transmission, consensus protocols, and digital encryption technology to validate transactions.  It is nearly impossible to counterfeit or double-spend cryptocurrency. 

Blockchain uses a public, digital ledger to create a fixed data chain of time-stamped transactions (blocks).  Blocks are chronologically strung together one after the other to form an immutable blockchain.  Transactions are cryptographically recorded and verified by a network of computers (consensus validation) that do not belong to any central authority. 

Every ten minutes, a set “block reward” of bitcoin is awarded to Bitcoin “miners.” Mining is the only way to “print” new Bitcoins into circulation. Miners use high power computers to solve complex math problems called hash functions to verify 1 megabyte, or 1 block, of Bitcoin transactions. 

Hash functions provide proof of work by processing data and generating another hash that matches the original data. Proof of work makes tampering with the blockchain very challenging; alteration of any kind would necessitate the re-mining of all subsequent blocks. 

Bitcoin’s supply issuance is strictly and algorithmically bound. The block reward is halved every 210,000 blocks, which takes about four years to mine. In 2009, the block reward was 50 Bitcoins every ten minutes, subsequently halving to 25 Bitcoins in 2013, 12.5 Bitcoins in 2016, and finally 6.25 Bitcoins in 2020. 

The supply of Bitcoin is capped by the blockchain code at 21 million. It would require network consensus to overwrite the coding language which is anathema to the value embedded in the Bitcoin network.  Currently, almost 18.5 million Bitcoins are in circulation, leaving approximately 2.5 million to be mined. The value of this “digital gold” will increase as its scarcity increases over time as fewer and fewer Bitcoins are “printed” with each successive halving until the supply is capped at 21 million.  The 21 millionth Bitcoin is expected to be mined in 2140. 

You can learn more about how Bitcoin and blockchains work in this 9 minute video from SciShow.


Blockchain and Fintech in China
China is the global leader in the use and development of blockchain technology.  China has by far the most blockchain patents in the world and more than 70% of the mining capacity.  Some of the biggest names in the crypto space are Chinese firms, including Binance, the world’s largest crypto exchange.  

Moreover, China is arguably the global leader in financial technology (fintech) solutions, particularly smart-phone based payment systems.  For example, the Chinese population has leapfrogged traditional credit card based payment rails with the dominance of mobile based Alipay and We Chat Pay.  Leveraging this fintech leadership, China has taken an early pole position in the development of an alternate global monetary and financial system by being the first country to issue a government backed digital currency


Why invest in Bitcoin?
Bitcoin is a worthy investment for enhancement of portfolio diversification and improvement of expected returns without significant addition of portfolio risk.  

Although the price of Bitcoin has been highly volatile over time, historically investors that hold Bitcoin for the longer term, called “hodlers,” have been richly rewarded as Bitcoin’s historical return per unit of risk (Sharpe ratio) has been much greater than 1.0 with a five year annual return of 88% through May 31, 2020 on volatility of 66%.  

This compares to Research Affiliate’s forward-looking expected returns and risk for traditional asset classes wherein emerging market equities are viewed as the most attractive asset class.  Research Affiliates estimated EM equity’s Sharpe ratio at 0.42 today based on 10% nominal annual returns and 21% expected volatility.  A Sharpe ratio of 1.0 or better is unheard of in the traditional investment world.

A Bitwise investment study entitled, “The Case for Bitcoin in an Institutional Portfolio” concluded that “adding Bitcoin to a diversified portfolio of stocks and bonds would have consistently and significantly increased both cumulative and risk-adjusted returns of that portfolio over any meaningful time period in Bitcoin’s history, provided a rebalancing strategy is in place.” 

This positive portfolio impact endured even in periods in which the price of Bitcoin fell. The magnitude and consistency of Bitcoin’s contribution to portfolio efficiency when added to a traditional 60/40 portfolio were remarkable.  Bitwise’s study found that achieving these portfolio benefits only required a few critical practices:  

  1. Hold Bitcoin for two years or more – the historical record of positive portfolio contributions quickly approached 100%
  2. Disciplined quarterly rebalancing – sell your winners and buy your losing positions to get back to targeted allocation percentages
  3. Well-thought out targeted allocation percentage – maximum drawdowns are the main limiting factor in deciding how much Bitcoin to add to investor portfolios.


Bitcoin and Investor Concerns
In March 2020, Fidelity Digital Assets released a study that surveyed nearly 800 European and American institutional investors. In general, institutional investors (hedge funds, pension plans, family offices and registered investment advisors) are keeping a keen eye on Bitcoin and other digital assets, and there are an increasing number of early-movers who have taken the crypto plunge. Key findings of the study include:

  • 36% of respondents say they are currently invested in digital assets (adoption rate is much higher among hedge funds but in the low single digits for pension plans).
  • 6 out of 10 respondents believe digital assets have a place in their investment portfolio.
  • The three most appealing characteristics of digital assets to investors: they are uncorrelated to other asset classes, are an innovative technology play, and have high potential upside. 
  • Investors’ perceived advantages of digital assets over traditional alternatives like hedge funds or private equity: higher liquidity, low transportation costs, low transaction costs, low storage costs, and unique return drivers.

Fidelity’s study also highlighted investor concerns regarding digital assets:

  • Price volatility (53% of respondents) – (mitigated by well-thought out position sizing as suggested by above Bitwise study)
  • Concerns about market manipulation (47%) – (this is a concern for all securities or currency markets.)  
  • Lack of fundamentals to gauge appropriate value (45%) – (fundamental analysis has recently been published in Plan B stock to flow cross-asset analysis).

President of Fidelity Digital Assets Tom Jessop commented, “Investor concerns are largely focused on issues that will resolve themselves as the market infrastructure evolves. We’re proud to be one of many service providers actively driving that evolution for the benefit of the ecosystem and traditional investors alike.”  Fidelity Digital Assets envisions a future where all types of assets are issued natively on blockchains or represented in tokenized form.  In other words, Fidelity expects all traditional assets (stocks, bonds, currencies, etc.) will be issued and held on blockchain or in tokenized form.


Grayscale Bitcoin Trust

Grayscale Bitcoin Trust’s (GBTC) absorption of 25% of newly-mined Bitcoins in 2020 indicates higher demand for crypto exchange-traded instruments among retail investors.   With a market capitalization of $3.5 billion, GBTC is the investment vehicle of choice for investors, particularly smaller, retail investors.  


It is very difficult to buy Bitcoin right now through traditional investment brokerage accounts due to limited investment offerings.  GBTC is one of the few liquid, publicly listed exchange traded vehicles that invests in Bitcoin.  GBTC provides titled, auditable ownership through a traditional investment vehicle, can be held in tax advantaged accounts, and maintains robust security and storage protocols. 

In late June, Servant Financial initiated small, toehold positions in GBTC of 0.5% to 1.0% in client model portfolios, depending on investor risk profiles.  Our statistical analysis using historical data suggested that adding a 1% position in GBTC will increase expected returns by 1% annually while only increasing risk by 0.3 to 0.4% across all client risk models.  

In addition to enhancing portfolio efficiency, GBTC provides schmuck insurance in the event the global monetary and financial system were to fail (an event not represented in the historical data).  The more irresponsible and extreme the monetary and fiscal policy actions of the government become, the more Bitcoin will appreciate as an increasingly scarce store of value.  In extremis,  GBTC, Bitcoin, and gold would be expected to massively outperform traditional asset classes in the event of a total system crash.  With a maximum downside of 0.5% to 1.0%, GBTC provides a “bit or byte” of peace of mind with asymmetric upside for this fat tail risk. 


It’s Time to Wake Up to Bitcoin
Institutional investors are waking up to the unique characteristics of Bitcoin and crypto currencies, particularly after the legendary hedge fund manager Paul Tudor Jones recommended Bitcoin as “the fastest horse in the race” to beat the Great Monetary Inflation (GMI) – “unprecedented expansion of every form of money unlike anything the developed world has ever seen” – that we are presently experiencing.  

As Fidelity’s Jessop indicated, the infrastructure for large scale institutional investment in Bitcoin and crypto currencies is still under construction.  Today, there are only a few access points suitable for institutional investors’ large scale deployment.  For example, Jones’ hedge fund will take a “low single digit position” in Bitcoin through futures markets rather than direct holdings of Bitcoin.  His $40 billion fund already has existing connectivity with the major futures exchanges and well-established investment policies and procedures.

The developing nature of the market presents a distinct advantage for smaller, more nimble retail investors to get in front of the institutional money flows.  Recent investor surveys suggest that many retail investors are getting ahead of their investment advisors in knowledge and acceptance of Bitcoin as a suitable investment and are pushing their advisors to #getoffzero and make an initial portfolio allocation.