Your Socially Responsible Guide

A good friend recently reached out to me for some investing advice. His question for me:

So I'm beginning to dip my toes into the stock market. And my main interest is in environmental companies that have ethical purposes, water scarcity, solar, wind, electric cars, etc. I'm looking for long term stocks, the kind of thing to, hopefully, one day pay for my kids college.

My friend (we'll call him Adam W.) may not know it, but he is primarily interested in socially conscious investing: Investing in b-corps or companies focused on the green economy. In order to generalize the request for my readers, I will provide some tips for how you can engineer a Targeted, Socially Responsible Portfolio.

Socially responsible investing takes guts and can create a tough situation for diversification.
In an October newsletter I discussed my first introduction to social impact investing:

I was first familiarized with the idea of Impact Investing at the Wharton Africa Business Forum. The keynote speaker and panelist was a man by the name of John Simon. Mr. Simon was the US ambassador to the African Union less than a decade ago. Now the founding member of Total Impact Advisors. Simon is credited with the modern manifesto of Impact Investing for development, and it can be read online for free at the Center for Global Development: More Than Money - John Simon.

I admire Adam's desire to do good with his assets. It's amazing to think that long-term investors, even those of middle income, will contributes millions+ dollars to their investments over the course of a 40-50 year hold cycle.

Before we get started:

The material here is predicated on a basic understanding of diversified, weighted portfolio investing. If you're not sure what this is, start by investing a bit in some education, and check out the Investor Reading List.

This article is for information and entertainment purposes only. Nothing you read is an offer or solicitation to buy or sell any investment.

Fundamentals

Let's just get it out of the way. There are a million and a half ways to go about this process. Before we start, I want to set a few ground rules:

1) We should seek low-cost mutual funds and ETFs in lieu of picking stocks.
2) Alternative investments can (and probably should) play a role in socially responsible investing. Because of the complexity of this topic, we will not include them for now.
3) It's hard to diversify evenly when limited to socially conscious funds. We should allow some leeway for asset classes that are not represented by this social-impact requirement.

Commission-free ETFs are usually available via brokerage affiliation. It's important to choose a brokerage that has a good representation of the kind of ETFs or mutual funds you are seeking. After the recommended reading, I would research a variety of brokerages to see who has the widest array of low-cost, socially conscious funds available for commission-free trading.

Because I am a Charles Schwab customer, I will use their funds as examples here. NOTE: This is not a specific endorsement of their offerings, although I have been consistently happy with their service and products.

Most brokerages will have a way for you to search and filter their low-cost ETFs that fit into the socially conscious strategy.
We'll find that 28 Schwab commission-free ETFs fit into the socially conscious category:

Symbol Name
GIVE AdvisorShares Global Echo ETF GIVE:NYSE Arca
RODI Barclays Return on Disability ETN RODI:NYSE Arca
WIL Barclays Women in Leadership ETN WIL:NYSE Arca
HECO EcoLogical Strategy ETF HECO:NYSE Arca
ETHO Etho Climate Leadership U.S. ETF ETHO:NYSE Arca
FAN First Trust ISE Global Wind Energy Index Fund FAN:NYSE Arca
FIW First Trust ISE Water Index Fund FIW:NYSE Arca
QCLN First Trust NASDAQ® Clean Edge® Green Energy Index Fund QCLN:NASDAQ
GRID First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund GRID:NASDAQ
MLPJ Global X Junior MLP ETF MLPJ:NYSE Arca
MLPX Global X MLP & Energy Infrastructure ETF MLPX:NYSE Arca
MLPA Global X MLP ETF MLPA:NYSE Arca
CGW Guggenheim S&P Global Water Index ETF CGW:NYSE Arca
TAN Guggenheim Solar ETF TAN:NYSE Arca
GRN iPath® Global Carbon ETN GRN:NYSE Arca
ICLN iShares Global Clean Energy ETF ICLN:NASDAQ
CRBN iShares MSCI ACWI Low Carbon Target ETF CRBN:NYSE Arca
DSI iShares MSCI KLD 400 Social ETF DSI:NYSE Arca
KLD iShares MSCI USA ESG Select ETF KLD:NYSE Arca
EVX Market Vectors® Environmental Services ETF EVX:NYSE Arca
GEX Market Vectors® Global Alternative Energy ETF GEX:NYSE Arca
KWT Market Vectors® Solar Energy ETF KWT:NYSE Arca
PZD PowerShares Cleantech Portfolio PZD:NYSE Arca
PHO PowerShares Water Resources Portfolio PHO:NYSE Arca
PBW PowerShares WilderHill Clean Energy Portfolio PBW:NYSE Arca
PUW PowerShares WilderHill Progressive Energy Portfolio PUW:NYSE Arca
LOWC SPDR® MSCI ACWI Low Carbon Target ETF LOWC:NYSE Arca
EQLT Workplace Equality Portfolio EQLT:NYSE Arca

As you can see, I have highlighted the funds that fit into the broad green economy in green.

Since Adam W. is focused on green funds, we will filter down to those for consideration. Another characteristic common in socially conscious ETFs is low total assets in the funds. Because all investors should aim for lower liquidation risk, we will ignore funds with less than $50m in total assets.

Symbol Name
FIW First Trust ISE Water Index Fund FIW:NYSE Arca
QCLN First Trust NASDAQ® Clean Edge® Green Energy Index Fund QCLN:NASDAQ
MLPX Global X MLP & Energy Infrastructure ETF MLPX:NYSE Arca
MLPA Global X MLP ETF MLPA:NYSE Arca
CGW Guggenheim S&P Global Water Index ETF CGW:NYSE Arca
TAN Guggenheim Solar ETF TAN:NYSE Arca
ICLN iShares Global Clean Energy ETF ICLN:NASDAQ
CRBN iShares MSCI ACWI Low Carbon Target ETF CRBN:NYSE Arca
GEX Market Vectors® Global Alternative Energy ETF GEX:NYSE Arca
PZD PowerShares Cleantech Portfolio PZD:NYSE Arca
PHO PowerShares Water Resources Portfolio PHO:NYSE Arca
PBW PowerShares WilderHill Clean Energy Portfolio PBW:NYSE Arca
LOWC SPDR® MSCI ACWI Low Carbon Target ETF LOWC:NYSE Arca

Let's try to put together a simple portfolio using these funds as a guide. Here is a distribution that will work fine for a younger (25-35) buy & hold investor:

  • 60% Large Cap Equities
  • 20% Small Cap Equities
  • 20% Fixed Income

Super simple portfolio, let's bias the home country (United States) at 65% in all categories except for fixed income. For example: 65% of the large cap equities should be based in the US. 35% should be based in other countries. Ideally I would like to use the same ratio in the small-cap category, but the fund availability may be limited.

To gauge fund size, use the Morningstar Investment Style box. Here is an example:

The market cap box will give you a good idea of where a fund may fit into your portfolio.

Breaking it all down

Let's throw all these funds into their various categories. Then we can fill in the gaps with other funds that are not necessarily socially conscious. They will help us with the fundamental weaknesses presented by this overt exposure to green energy.

Large Cap (60%) Small Cap (20%) Fixed Income (20%)
Domestic (65%) MLPX
MLPA
CGW
CRBN
LOWC
FIW
QCLN
TAN
GEX
PZD
PHO
PBW
None
Foreign (35%) ICLN None None

As you can see, this kind of investing is heavily weighted towards domestic and small-cap companies. Another piece of note is that many of the funds in the 'large' category are closer to mid-cap funds. They were placed in the 'large' category due to their relative size.

Here is a sample portfolio:

Symbol %
Large Cap (60%) MLPX 19.5%
CRBN 19.5%
ICLN 21%
Small Cap (20%) TAN 10%
PBW 10%
Fixed Income (20%) SCHZ 20%

I would like to re-emphasize the sample nature of this exercise: This is about discussing thought process, not copy-paste portfolio creation. Here are some noted weaknesses:

  • The entire portfolio is heavily invested in energy companies: thus high correlation.
  • The foreign holdings are not super diversified, and have limited emerging market exposure (this is a standard limitation with green funds).
  • Companies err on the side of mid-cap. As-is, the portfolio is slightly biased towards medium and smaller operators.
  • These funds are on the smaller end in regards to total assets.
  • It's very likely that there are many more brokerages with better green offerings. Do your research in advance so you are not pushed into limited funds with low total assets due to lack of interest.

At this point, alternative assets and non-socially-conscious ETFs may help fill in the gaps.

Socially conscious investors are likely to sacrifice some return in exchange for ethical but more limited investment choices. Their option remains better than a savings account. I think it's important to make a confident declaration of why you invest in the first place. 2-3% per year is a small sacrifice for peace of mind.

Constructing a socially-conscious portfolio? Pear of the Week has a method and provides the right mindset for these assets: Cost / benefit and tradeoffs.