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 presently provide a Broad Impression portfolio and two extra, extra centered SRI portfolio choices: a Social Impression SRI portfolio (centered on social governance mandates) and a Local weather Impression SRI portfolio (centered on climate-conscious investments). These portfolios symbolize a diversified, comparatively low-cost resolution constructed utilizing alternate traded funds (ETFs), which can be regularly improved upon as prices decline, extra knowledge emerges, and consequently, the supply of SRI funds broadens.

How will we outline SRI?

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

1. Decreasing publicity to investments concerned in unsustainable actions and environmental, social, or governmental controversies.
2. Rising publicity to investments that work to deal with options for core environmental and social challenges in measurable methods.
3. Allocating to investments that use shareholder engagement instruments, corresponding 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 specialists now favor “sustainable investing” because the identify for the complete class).

Our SRI method makes use of SRI mandates primarily based on a set of trade standards often 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 elements. 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. Quite, Betterment identifies ETFs which were categorised 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 side of enhancing a portfolio’s ESG publicity is lowering publicity to corporations that interact in sure actions which may be thought of undesirable as a result of they don’t align with particular values. These actions might embody promoting tobacco, navy weapons, civilian firearms, in addition to involvement in latest and ongoing ESG controversies. Nonetheless, SRI is about extra than simply adjusting your portfolio to attenuate corporations with a poor social impression.

For every Betterment SRI portfolio, the portfolio development 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 vital direct methods a shareholder can affect an organization’s resolution 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 quite a lot of subjects corresponding 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 may vote on these subjects by means of a proxy card. A shareholder can even make an express suggestion for the corporate to take a selected plan of action by means of a shareholder proposal.

ETF shareholders themselves don’t vote within the proxy voting technique of underlying corporations, 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 lively position participating with underlying corporations by means of proxy voting to advocate for extra socially accountable company practices. These issuers use engagement-based methods, corresponding to shareholder proposals and director nominees, to interact with corporations to result in ESG change and permit buyers within the ETF to specific a socially accountable desire. 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 current SRI choices out there have severe shortcomings.

Many SRI choices at this time sacrifice enough 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. In line with 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 courses. 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 buyers to sign their curiosity in ESG points to corporations 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 varieties of corporations above all else, sure approaches to ESG will inevitably fall wanting expectations. For instance, most of the largest ESG funds centered on US Giant Cap shares embody some vitality corporations that interact in oil and pure gasoline exploration, like Hess. Whereas Hess may not meet the standards of the “E” pillar of ESG, it might nonetheless meet the standards when it comes to the “S” and the “G.”

Understanding that buyers might desire to focus particularly on a sure pillar of ESG, Betterment has made three SRI portfolios out there. The Broad Impression portfolio seeks to stability every of the three dimensions of ESG with out diluting totally different dimensions of social accountability. With our Social Impression portfolio, we sharpen the give attention to social fairness with partial allocations to gender and racial range centered funds. With our Local weather Impression 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 presently in the marketplace. With out enough liquidity, each execution turns into costlier, making a drag on returns. Median each day greenback quantity is a method of estimating liquidity. Increased quantity on a given asset means you can rapidly purchase (or promote) extra of that asset out there with out driving the worth up (or down). The diploma to which you’ll drive the worth 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 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 recurrently. In balancing value and worth for the portfolios, the choices are restricted to funds of sure asset courses corresponding to US shares, Developed Market shares, Rising Market shares, US Funding Grade Company Bonds, and US Excessive High quality bonds.

How is Betterment’s Broad Impression portfolio constructed?

Betterment’s Broad Impression 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 probably the most liquid, highlighting their reputation amongst buyers. So as to keep geographic and asset class diversification and to fulfill our necessities for decrease value and better liquidity in all SRI portfolios, we proceed to allocate to some funds that don’t replicate SRI mandates, significantly in bond asset courses.

How is Betterment’s Local weather Impression portfolio constructed?

Betterment gives a Local weather Impression portfolio for buyers that need to spend money on an SRI technique extra centered on the environmental pillar of “ESG” fairly than specializing in all ESG dimensions equally. Betterment’s Local weather Impression 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 Impression portfolio was designed to present buyers publicity to climate-conscious investments, with out sacrificing correct diversification and balanced value. Fund choice for this portfolio follows the identical tips established for the Broad Impression portfolio, as we search to include broad primarily based climate-focused ETFs with enough liquidity relative to their dimension within the portfolio.

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

The Local weather Impression 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 corporations with a decrease carbon footprint. By investing in CRBN, buyers 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 method we are able to measure the carbon impression a fund has is by 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 knowledge from MSCI, Betterment’s 100% inventory Local weather Impression portfolio has carbon emissions per unit gross sales which might be almost 50% decrease than Betterment’s 100% inventory Core portfolio as of February 8, 2024.

Moreover, a portion of the Local weather Impression portfolio is allotted to fossil gasoline reserve funds. Quite 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 gasoline, and thermal coal. By investing in fossil gasoline reserve free funds, buyers are actively divesting from corporations with a number of the most destructive impression on local weather change, together with oil producers, refineries, and coal miners corresponding to Chevron, ExxonMobile, BP, and Peabody Power.

How is Betterment’s Social Impression portfolio constructed?

Betterment gives a Social Impression portfolio for buyers that need to spend money on a technique extra centered on the social pillar of ESG investing (the S in ESG). Betterment’s Social Impression portfolio invests property in socially accountable ETFs and is constructed utilizing the next mandates: ESG, gender fairness, racial fairness, and shareholder engagement. The Social Impression portfolio was designed to present buyers publicity to investments which promote social fairness, with out sacrificing correct diversification and balanced value. Fund choice for this portfolio follows the identical tips established for the Broad Impression portfolio mentioned above, as we search to include broad primarily based ETFs that concentrate on social fairness with enough liquidity relative to their dimension within the portfolio.

How does the Social Impression portfolio assist promote social fairness?

The Social Impression portfolio shares most of the similar holdings as Betterment’s Broad Impression portfolio. The Social Impression portfolio moreover appears to additional promote the “social” pillar of ESG investing, by allocating to 2 ETFs that particularly give attention to range and inclusion — Impression Shares NAACP Minority Empowerment ETF (NACP) and SPDR SSGA Gender Range Index ETF (SHE).

NACP is a US inventory ETF provided by Impression 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 quite 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 robust diversification. The tip result’s an index which gives better publicity to US corporations with sturdy range insurance policies that empower staff no matter race or nationality. By investing in NACP, buyers 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 buyers to spend money on extra female-led corporations in comparison with the broader market. So as to obtain this goal, corporations are ranked inside every sector based on 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, buyers are allocating extra of their cash to corporations which have demonstrated better gender range inside senior management than different corporations of their sector.

Conclusion

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