Impact Investing: 12% Return on Socially Responsible Portfolio

Impact Investing: 12% Return on Socially Responsible Portfolio

Executive Summary

A high-net-worth individual approached Legacy Bridge Advisors seeking to align their $2 million investment portfolio with their deeply held charitable values, primarily focusing on environmental sustainability and community development. Concerned about potential underperformance compared to traditional investments, the client sought assurance that socially responsible investing (SRI) wouldn't significantly hinder their financial goals. Legacy Bridge Advisors, led by Patricia Brennan, meticulously constructed a diversified SRI portfolio utilizing ESG-rated funds and individual stocks, generating a 12% return within the first year, proving that ethical investing and strong financial performance can coexist.

The Challenge

John Harrison, a successful entrepreneur and philanthropist, approached Legacy Bridge Advisors with a unique challenge. Having accumulated a substantial $2 million in investable assets, John felt increasingly conflicted between his investment strategy and his commitment to environmental sustainability and social justice. He was contributing significantly to various charities but felt his investments were inadvertently supporting industries with practices counter to his philanthropic efforts.

John expressed concern that prioritizing ESG (Environmental, Social, and Governance) factors would necessitate accepting lower returns. He cited news articles highlighting the perceived trade-off between social responsibility and financial gain, referencing studies suggesting that exclusionary screening (avoiding certain industries) could negatively impact portfolio performance. John specifically mentioned his unease with holding shares in fossil fuel companies and those with poor labor practices, but worried about the potential impact on his retirement goals. He needed a solution that aligned with his values without jeopardizing his financial security.

Furthermore, John desired transparency and accountability in his investments. He wanted to understand exactly how his money was being used and the specific impact it was having on the environment and society. He found it difficult to assess the ESG performance of various companies and funds using publicly available information alone, lacking the time and expertise to conduct thorough research. He initially considered donating the $2M to his favorite charities, but realized he could create a much larger, long-term impact through impact investing. He set a clear goal: to achieve a return comparable to a traditional diversified portfolio (targeting at least 7% annually) while actively contributing to positive social and environmental outcomes. This required careful selection of SRI investments and rigorous performance monitoring.

The Approach

Patricia Brennan, a senior portfolio manager at Legacy Bridge Advisors, adopted a comprehensive approach to address John's challenge, focusing on diversification, rigorous ESG screening, and proactive portfolio management.

First, Patricia conducted a thorough discovery process to understand John's specific charitable priorities and risk tolerance. This involved in-depth conversations about his values, his desired level of engagement with the companies in his portfolio, and his long-term financial goals. Based on this, Patricia developed an Investment Policy Statement (IPS) that explicitly outlined the portfolio's SRI objectives and performance benchmarks.

Next, Patricia leveraged Morningstar Direct to screen for funds and companies with strong ESG ratings. She focused on identifying companies that demonstrated leadership in areas such as carbon emissions reduction, renewable energy adoption, fair labor practices, and community engagement. She utilized various ESG rating methodologies, including those provided by MSCI and Sustainalytics, to gain a comprehensive view of each investment's social and environmental impact. Patricia prioritized funds with transparent ESG reporting and a demonstrated commitment to shareholder engagement.

Patricia then constructed a globally diversified portfolio, incorporating both ETFs (Exchange Traded Funds) and individual stocks. ETFs were selected to provide broad exposure to different sectors and geographies, while individual stocks were chosen based on their specific ESG performance and potential for long-term growth. The portfolio included investments in renewable energy companies, sustainable agriculture businesses, and companies developing innovative environmental technologies. She allocated 30% to global ESG ETFs, 40% to US-based ESG ETFs, 20% to individual stocks (selected based on high ESG scores), and 10% to green bonds.

Patricia implemented a dynamic asset allocation strategy, regularly reviewing and rebalancing the portfolio to maintain its desired risk profile and alignment with John's values. This involved monitoring ESG performance, tracking news events related to the companies in the portfolio, and adjusting holdings as needed to reflect changing market conditions and evolving sustainability standards. She also committed to providing John with regular updates on the portfolio's financial performance and its social and environmental impact, using metrics such as carbon footprint reduction and job creation.

Technical Implementation

The construction of John's SRI portfolio involved several key technical elements:

• ESG Screening with Morningstar Direct: Patricia utilized Morningstar Direct's ESG screener to filter funds based on various sustainability metrics, including environmental risk scores, carbon intensity, and social responsibility ratings. She established minimum ESG score thresholds to ensure that all investments met John's ethical standards. The screening process involved analyzing hundreds of potential investments, narrowing the selection down to those with the highest ESG ratings and a demonstrated commitment to sustainable practices.

• Portfolio Diversification: The portfolio was diversified across asset classes, sectors, and geographies to mitigate risk. ETFs were used to gain broad exposure to different market segments, while individual stocks were selected based on their specific ESG profiles and growth potential. The allocation was roughly:

  • 30% Global ESG ETFs (e.g., iShares MSCI ACWI ESG Screened UCITS ETF)
  • 40% US ESG ETFs (e.g., Vanguard ESG U.S. Stock ETF)
  • 20% Individual Stocks (e.g., Tesla, Vestas Wind Systems)
  • 10% Green Bonds (e.g., World Bank Green Bonds)

• Performance Benchmarking: The portfolio's performance was benchmarked against the MSCI KLD 400 Social Index, a widely recognized index of socially responsible companies. This allowed Patricia to compare the portfolio's returns to those of other SRI investments. She also tracked the portfolio's alpha, which measures the portfolio's risk-adjusted return relative to the benchmark.

• Carbon Footprint Analysis: Patricia conducted a carbon footprint analysis of the portfolio to measure its contribution to climate change. This involved calculating the weighted average carbon intensity of the portfolio's holdings, based on their reported greenhouse gas emissions. The goal was to reduce the portfolio's carbon footprint compared to a traditional diversified portfolio.

• Regular Rebalancing: The portfolio was rebalanced quarterly to maintain its desired asset allocation and ESG profile. This involved selling overweighted assets and buying underweighted assets to bring the portfolio back into alignment with the IPS. The rebalancing process also considered any changes in ESG ratings or sustainability standards, ensuring that the portfolio continued to reflect John's values.

• Reporting: A detailed report was generated quarterly showing the portfolio's financial performance, ESG metrics, and impact on the environment and society. The report included information on the portfolio's carbon footprint, water usage, and waste generation, as well as its contribution to job creation and community development. This provided John with transparency and accountability, allowing him to track the positive impact of his investments.

Results & ROI

The SRI portfolio generated a 12% return in its first year, exceeding both John's initial goal of 7% and the performance of the MSCI KLD 400 Social Index, which returned 9.5% during the same period.

• Financial Performance: The portfolio's 12% return translated to a $240,000 increase in value. This demonstrated that aligning investments with charitable values does not require sacrificing financial performance.
• ESG Performance: The portfolio's ESG score, as measured by Morningstar, was significantly higher than that of a traditional diversified portfolio. The portfolio's carbon footprint was 40% lower than the average for a comparable portfolio.
• Impact Metrics: The portfolio's investments supported the creation of over 500 new jobs in the renewable energy sector. They also contributed to the reduction of 10,000 tons of carbon dioxide emissions.
• Client Satisfaction: John expressed high satisfaction with the portfolio's performance and its alignment with his values. He appreciated the transparency and accountability provided by Legacy Bridge Advisors.

The success of this case study provided concrete data to the team at Legacy Bridge Advisors. Previously, when pitching SRI to clients, it was difficult to estimate potential returns. Now they could reference the 12% and have more meaningful discussion.

Key Takeaways

• SRI Can Outperform Traditional Investments: This case study demonstrates that SRI portfolios can generate competitive returns compared to traditional investments. By carefully selecting companies with strong ESG practices, advisors can create portfolios that align with client values without sacrificing financial performance.
• Diversification is Key: Diversifying across asset classes, sectors, and geographies is crucial for mitigating risk in SRI portfolios. This helps to ensure that the portfolio is not overly reliant on any one sector or company.
• Transparency and Accountability are Essential: Providing clients with regular updates on the portfolio's financial performance and its social and environmental impact is essential for building trust and demonstrating the value of SRI.
• ESG Screening is Crucial: Using robust ESG screening tools, such as Morningstar Direct, is essential for identifying companies with strong sustainability practices. This helps to ensure that the portfolio is aligned with the client's values.
• Start with the Client's Values: A discovery process to understand the client's values allows an advisor to align the client's investments with their charitable values which can improve client retention.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify ESG investment opportunities and create custom reports that quantify social and environmental impact. Visit our tools to see how we can help your practice.