Ep 79: Aligning Your Investments With Your Values

Ep 79: Aligning Your Investments With Your Values

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The Smart Take:

Have you heard of ESG? Many investors today are selecting investments in part based on Environmental, Social, and Governance (ESG) criteria.

Don’t like fossil fuels, weapons, or pornography? Want to focus on companies that have diverse boards, executive teams, and overall workforce? Have religious beliefs you want to follow when it comes to investing? Then ESG may be right for you.

Hear Kevin discuss solutions for those seeking to align their investments to their ESG values and discuss challenges and investment considerations in doing so. He’ll also share several recent client examples that have pursued ESG investing.

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The Host:

Kevin Kroskey – About – Contact

Intro:                                   Welcome to Retire Smarter, with Kevin Kroskey. Find answers to your toughest questions, and get educated about the financial world. It’s time to Retire smarter.

Walter Storholt:               It’s another edition of Retire Smarter. Glad to have you with us today. Walter Storholt holds alongside Kevin Kroskey, President and Wealth Advisor at True Wealth Design, serving you in Northeast Ohio and Southwest Florida, along with the greater Pittsburgh area. You can find us online at truewealthdesign.com for past episodes of the show, and to schedule a 15-minute call with an experienced advisor on the True Wealth team. Just click on the “Are we right for you?” button.

Kevin, good to have you back with us today. How are you?

Kevin Kroskey:                  Walter, I’m great. We are recording as the Olympics are going on, and it’s been fun to watch the Olympics with my almost eight-year-old. And, you think about the newspaper; oftentimes, the sports page, the sports section, is really the only place where you see positive news. And just to relate that to her, and just see these people, and how they show how hard they work and what they achieve. And some fail to achieve, which is valuable lesson there, too. But it’s been pretty cool to go through this with my daughter recently.

Walter Storholt:               Yeah. Somehow, the Olympics are becoming even incredibly politicized this year, and it’s like, “Let’s just” I love how you said that. There’s lessons of goodness to be learned here, and of success; but also, let’s learn through the failures. Whatever happened to us, where somebody can’t fail? And we all learn from it and have compassion for that failure. And that it’s okay to fail in life sometimes; not to get too deep here at the beginning of the show, but it’s the Olympics. Just enjoy it and quit complaining about it. Right?

Kevin Kroskey:                  Well, maybe I’ve been, I don’t know, just a bit out of tune. But yeah, I haven’t noticed that part that much, so I’m thankful for that.

Walter Storholt:                 Oh, that’s good. You must be staying off of Twitter and listening to the local sports shows, and those kinds of things. Probably a good, healthy thing to do.

Kevin Kroskey:                  Yeah. It’s work, it’s family, and if there’s something on the TV, it’s usually for the three-to-eight-year-old population. So, that’s my world.

Walter Storholt:                  Nice. I do find myself more and more trying to just stay out of the analysis world, right? Like we’re in such a world where everybody analyzes everything for us. If you actually consciously try to avoid that stuff, and just make up your own mind about things again. If you can get back to that mode of life, where you watch or read or absorb something, and then make up your own mind; it’s so interesting to then make your mind up, and then go see what other people are saying about it. And either sometimes how inline you are, and sometimes how totally different from everybody else’s opinions out there are. It’s an interesting exercise. I encourage somebody to try that if you find yourself just always reading what other people. You go to an article, and you immediately go to the comment section, instead of actually reading the article first for yourself; that strategy to do that.

Well, we’ve got a great show on the way today. And I am interested in this, Kevin because I’ve been hearing more and more people starting to talk about it. And I don’t know if I really understand it, and is it really all that big of a deal? And I know it’s just a little bit of a small part of what you’re going to cover today, but I keep seeing this buzzword or acronym, of ESG everywhere, as it relates to finances and investing. And I’ve heard of socially responsible investing before. And I know you’re going to touch on some of these things, but we’re going to try and align our investments with our values. And I would ask the question, Kevin, should we? Should we make these things the most important thing in our investing life? And I’m interested in your perspective on this today.

Kevin Kroskey:                  Well, that’s a bit of a carefully crafted question; or at least I need to have a carefully crafted response. Should you? I’m not going to shit all over everybody today, so don’t worry about that. But on one hand, we’ll talk about this ESG, and really, the values-based investing, if you will. And then I’ll talk about some of the financial aspects of it, as well as, it relates to investments. And then, like with anything, and somebody that we’re talking to, from a client perspective, our job is to make it very clear, pros and cons. If there is a recommended course of action, then we will recommend it and why; but ultimately, it’s our job to make things clear, so our clients can make a choice that’s right for them. And particularly when you get into something on the value side, that’s a very personal decision; so there’s not, I would say, we are not making a recommended course of action whether you should or shouldn’t, but if it’s something that you decide to do, it’s more about, “How are we going to best implement?”

Maybe that’s the way that we’ll tackle this today. But Walter, you mentioned a couple of ESG, Environmental, Social, and Governance. Environmental is, I think you get it, its fossil fuels, global warming, things along those lines, those sorts of concerns, pollution. Social is a little bit, I don’t want to say a little bit broader; you could really have religious views that come under here. We will talk about a couple of client examples recently, where we had clients that are practicing Catholics, that wanted to have their investments aligned with their beliefs. And we have another client who’s Muslim, and wanted the same; but, a little bit different, and aligned with her beliefs. Social could also be some other things in terms of child labor; certain companies maybe have arguably exploited that in the past, in some third world countries, things along those lines.

Governance could be a few different things as well. Some people will put diversity under here, “Hey, what does the executive makeup look like? What does the board look like? How many women? How many minorities?” Things along those lines. That’s broadly speaking. And again, like anything, it could mean different things to different people. But very generally speaking, that’s how I understand it.

Another name for this, at least for the social part, is socially responsible investing, or SRI. It seems like all these acronyms change over time. Another phrase that I’ve heard is called Impact Investing. They all sound good, but that’s just the name. And like we talked about it in a couple of podcasts ago, when we were talking about risk tolerance, using names sometimes can be quite broad. What is environmentally friendly for one person is maybe not for another.

I’ll give you a personal example of that, that I just chuckled about thinking of. My sister is very environmentally aware. Any toys that she gets for our girls have to be wood, no plastic, things like that. And I’m cool with that. I like beaches. I don’t want plastic straws ending up and hurting the turtles or the fish or whatever. I have no problem getting a metal straw, or whatever it may be, and reusing it; makes sense. We use containers that we fill up at the water cooler, and don’t throw away a bunch of plastic bottles. That’s what we do, my wife and I, and our family. Those are our values. But where we draw the line; we have some friends that are, we refer to them as “crunchy,” if you will. If, I’m talking about, Walter. But they-

Walter Storholt:               Granola is our term?

Kevin Kroskey:                Granola. Crunchy. You got it. And we have-

Walter Storholt:               Our neighbor across the street used to cut the grass without the gas-powered lawnmower, so it was the old school, what was it? Real mowers? Is that what they used to call those? Just the nice, silent cutting of the grass.

Kevin Kroskey:                  Well, the example I was thinking of for us is, our three-year-old is not yet potty trained. She’s not yet three either, so we’re still using diapers. And we have several crunchy friends, granola friends, that-

Walter Storholt:                  Did you… Reusable diapers?

Kevin Kroskey:                  They use reusable diapers. And “hell no” is the phrase that comes to mind for us. Yes, we are environmentally friendly, but we have limits to what we consider environmentally friendly against our convenience. And everybody does. Hopefully, that was at least a tad bit humorous. But we all have these beliefs. And when you think about it, I’ll talk about this under maybe some challenges, but when you think about our world in general, it’s so interconnected. You could say, “Well, I don’t want to support pornographers.” Well, where are you going to draw the line? They probably use Apple Macintosh computers to do a lot of their graphics or something like that. Are you going to say, “Well, I’m not going to buy Apple either,” because their computers are used in pornography production or something of the sort.

But you got to just, companies, big companies, are global. There could be people in their supply chain that are abusing some child labor practices over in these developing countries. There’s some things that are qualitative, some things that are quantitative. Maybe we don’t get lost too far in the weeds of this stuff, but if you can get your investing to be a little bit better aligned with your values than what currently is, and that’s important to you, then at least we’re heading in the right direction. We don’t have to worry about things being exactly black or white. That’s me saying it; somebody else, their values may be very black and white, so we’ll talk through that.

But some other examples I gave, weapons, tobacco, gambling, fossil fuels, pornography; again, diversity, like I mentioned. These are all things that fall under that umbrella of ESG investing. And the way that it works in practice, is that if you think of the market, think of just the S&P 500. Well, you would look at that market, and then start screening some companies out that don’t meet the criteria consistent with your values. Weapons, for example, a popular screening is companies that aren’t at least 20% of their total revenue through the production or sale of conventional or nuclear weapons, weapon systems, or critical components of these products, so on and so forth. 20% of the annual revenue is pretty objective; critical components of these products is, I would say, a lot more subjective.

Somebody is making these sorts of decisions. Usually, it’s some sort of screening service that is doing that. Some of the services that are out there, Morningstar has a sustainability rating; they’re probably, I’m sure everybody’s heard of Morningstar; they’re the 800-pound gorilla in the mutual fund ETF screening universe. They have a sustainability rating. Sustainability is a little bit more geared towards that environmental or that E in the ESG.

We had a client recently, we noticed there was a lot of screening done for people of the Muslim faith by a company, I believe, called Yasser Limited. So that was one that we’ve seen there that’s being used in some of these funds that are consistent with Muslim beliefs and Halal investing. Another one was the United States Conference of Catholic Bishops, socially responsible investment guidelines. Usually, you’re having some sort of service that defines these criteria; some objective, some a little bit more subjective.

Another subjective example under child labor, companies that have had major recent controversies relating to child labor infractions in the US or abroad. So, major, recent controversies. It’s subjective there; what’s major? What’s recent? That’s a broad characteristic; but somebody is making these decisions at these different bodies that I just mentioned, or others, that is basically filtering out these companies. For the S&P 500, after you go through the screening process, depending on how rigid it is, or what have you; rather than having 500 companies, maybe you end up with 420 companies or something of the sort. So on a high level, that’s how it works. So, Walter, I know you had a question about this ESG. But how are you? How am I educating you so far?

Walter Storholt:               Well, good. Because it sounds like this takes on different layers, right? It’s an individual company basis. But that sounds like it can also take a lot of work to try and handpick different companies, and that sort of thing. Is there an easier way to be ESG, or Socially Responsible Investing, or this Impact Investing, that doesn’t require the individual screening of every single company for an investor?

Kevin Kroskey:                  Well, if you’re using a screening service, you will have. Well, I’ll answer it this way.

Walter Storholt:               They’re going to give you a menu you can choose from; a little bit easier than having to do it on your own, basically?

Kevin Kroskey:                  If you’re going out, and there’s the packaged product solution or the off-the-shelf solution; and whether that’s in a mutual fund format or exchange-traded fund format. And if you just went out and typed in, say ESG mutual funds, you’ll find several of them that are out there. And what they will generally do, whether it’s BlackRock or PIMCO, or Dimensional Fund Advisors, or any mutual fund family for that matter; they’ll generally employ one of these screening services, and overlay that on top of their investment strategy, and start screening some of these companies out. It is truly a packaged product.

You try to find something that is in alignment with what you want. Depending on how much information you could get, maybe you can see what some of the exclusions are, broadly speaking, and then what companies, if you wanted to, dive into it. Hopefully, you could, and it wasn’t a black box. Some of them are a little bit of a black box, and what one constitutes social, and socially screened, could vary from something else. There’s definitely some searching there, just from a values-based consideration. So those are packaged products.

Another option is really to get a custom solution, and this could be customized. Generally, it’s done under what they call a Separately Managed Account or SMA, or this can also be done in a similar fashion. Sometimes we call it Direct Indexing, too. Let’s just say, we go back to the S&P 500 example, and we can just go out and buy all those 500 stocks directly. Maybe we don’t use the mutual fund, but we know there are certain companies that we want to screen out, because of our values, because of our beliefs, and then we could just go ahead and do that directly. That’s maybe Direct Indexing.

Separately Managed Accounts often implies that there’s another manager that’s doing it, that’s doing the screening and the management of the account. But the whole point of the non-packaged product is, it is purely customizable. The sky’s the limit. You can utilize one of those screening services. You could go ahead and screen out entire industries, Halal investing, for example; we had to work through interest. Banks derive a lot of their income from interest; and so, much of the financial sector, if you’re going to adhere to those investing beliefs, then you just need to screen out the whole industry. And we had a client that. She did not want to screen out. She is a physician. She did not want to screen out companies that were doing stem cell research or had some hand in contraceptives. So that was a customization that.she just used maybe the more broadly used here, domestically in the US. Some of the Catholic screening that wasn’t going to work for her beliefs, or at least not as much as she wanted it to work for her beliefs.

The SMAs, and I’ll talk about this in a future episode, too. Technology has really brought down the cost for these SMAs. They used to be, really the playground of the wealthy. We use one provider that literally, you had to have well into the seven figures to utilize their SMA. That’s now down to, on the order of about $500,000. The costs aren’t all that different for the SMA from the mutual fund, just because of the technology that we can avail ourselves of today. It’s become much more scalable in the customization.

It’s pretty cool what you can do. And we have some company insiders at local companies, whether it’s Goodyear or BW, or some other companies like that. And they have restrictions on when they can buy or sell their company stock. We can actually add those restrictions onto these SMAs, or this Direct Indexing, so they don’t run afoul of those SEC rules that they’re under.

But packaged products or custom solutions, they both can move you in that right direction. SMAs are a little bit more, there’s a little bit more to it. And that’s why we’ll talk about it a little bit. Maybe we’ll do it next episode since we’re talking about it now. But there’s definitely some benefits there, some more complexity; but for the right investor, they make a lot of sense and something that we’ve been doing more of these days.

While those are some of the solutions that you can, you can have an email yourself of let, me pivot to some of the challenges. My belief before, and this was years ago; and full disclosure, we’re not. I’m one of those, “What you see is what you get” sort of guys. My personal belief, we were not doing any of these sorts of ESG investing in our, my wife and I, in our own investments. This is something that we’ve learned about over the last several years for clients that have inquired about it. Certainly, you’re seeing and hearing more of it as well. But it’s not something that I’m currently practicing. We’re still buying the disposable diapers, so to say. But these options have always cost more money.

When I looked at it, I was like, “Wow. It costs a lot more. The results really weren’t all that favorable as well.” There was, at least in my mind at the time, and what the evidence was showing, was there was a true cost to doing this. And you were foregoing, likely foregoing, some more dollars that you could earn on your investments. And then arguably, you take that excess money, and you go do something with it yourself; something charitable, donate to a cause or charity, or make a difference yourself, make your own impact donation if you will.

And those costs have definitely come down, and there’s a lot more options within this ESG universe, that they do pass the smell test, so to say. But they are still going to be a little bit more costly. Some of the options that we use, just as an example; if we don’t have a social or environmentally screened option, maybe it’s like 0.04% or 0.06% more in the expense ratio. It’s a pretty small number, just in dollar terms. If you’re talking about 0.06% higher expense ratio on $500,000, you’re talking $300 bucks a year. A lot of people will just look at that and say, “Okay, that’s fine. That’s worth it to me. And my values, it gets me closer to what I want to do.”

That used to not be the case; the cost differential used to be a lot wider, and the investment results used to be a lot more varied, and generally, these options underperformed. you’re not really seeing that so much anymore, so it’s become less of a concern. But there’s still somewhat of an additional cost there. That’s always important to know.

And the other thing that happens is, whenever you’re doing the screening, depending on how aggressive you are in screening, then you may really limit your diversification opportunities. Just to give you for example, and I’ll just talk broadly about the funds that we’ve used for clients. If we look at our core US fund; to go from our regular fund to the socially screened fund, there’s more than 500 companies that are coming out, and there’s about almost a 20% change in the portfolio composition. Different companies have different market values. You have a small, local company that’s publicly traded, versus a big global behemoth like Microsoft. It’s not just the number of companies, but it’s how many dollars are really changing; so it’s the composition. And a 20% change of the portfolio is pretty substantial.

But if we were to go and look at our core fund, over to the sustainability screen fund; and it’s really even more prevalent outside of the US, so I’ll go there. But if we just look at foreign developed markets, 24% of the fund is changing. We go into emerging markets, which again, they’re still developing, they’re still emerging, China is a bigger polluter, things along those lines; 54% of the fund weighting changes. Now we’re getting into the area where there’s some serious changes to the investment profile and the investment strategy that we’re doing; not the strategy, but we’re just really foregoing the diversification that we initially started with. We have to really think through that.

And when you’re starting to screen out a lot of companies, you very well may have more disparate returns, and maybe some under-performance. It’s just, nobody can predict the future, but diversification is one of those things where it’s like a free lunch. The more that you can get, generally the better it works. Maybe we can bring out the egg heller here, Walter, but the lower the terminal wealth dispersion that you have, if you want to go back and listen to that episode. But these are some things, these are some of the trade-offs, and some of the challenges that you have to work through.

And then just lastly, I already mentioned it, but just to reiterate, some of the measurements are objective, while others are more subjective. So who’s making those subjective decisions for these third-party companies? Are they consistent with what you want to do? And again, it’s difficult to decide where to draw the line in our interconnected global economy.

Walter Storholt:               I’m curious; you’re obviously meeting with folks every day, and your other advisors have people just coming through the door constantly. How aware of all of these different types of investing, whether it’s the ESG or the Socially Responsible Investing or Impact Investing, or wanting to stay away from these different categories, whether it be on a religious basis or something else; how often are you having people come in and request for guidance in this way? Is this a majority, or is it still a pretty small minority that wants to invest like this, and makes this a top priority or concern?

Kevin Kroskey:                  We currently have a little more, probably you can count them on two hands that are doing it. And those are people that specifically asked us about it. However, as in most things, if somebody has a question, there’s probably a lot of other people that have that question who just haven’t asked. So, we’ve done all the work here on what we see as good solutions for, just from the investment perspective. And we’re familiar with some of the screening. We’re just being more proactive. And it’s one of the reasons why we’re talking about today; just being more proactive, talking about this with our clients. And letting them know, educating them that, “Hey, it is an option. Yes, there’s a little bit of a higher cost to it, but it’s not that much. If this is something that’s important to you, then we’re certainly happy to talk to you about it. And we’ve already figured out how to build it into your investment plan, your financial plan, into our operations, into our trading software, so on and so forth.”

It’s really us, rather than being reactive, we’re just taking. We’ve done the work for several clients now over the years that have asked the question, so we’re going to start writing and talking about it. And I suspect there’s many, many more clients in our 300+ client base that would like to do some form of this. So we’ll see what happens. But the SMA solutions, too, they’re often used for these ESG purposes. There’s some other benefits that we’ll talk about in another episode.

But for clients that have what we call Legacy Holdings, maybe they have some stock that they inherited or bought many decades ago, and is really, really would be really expensive, tax-wise, to sell. We can actually better incorporate some of these legacy holdings into a Separately Managed Account, and build around those, and really get the investment profile that we want. So there’s a few different reasons that we’re doing this, and talking about it now, but we’re going to continue to talk about it proactively. I would suspect we’re going to have several handfuls more of people that want to do this.

Walter Storholt:               Very interesting to hear some of these stories. And I think it’s just really helpful to understand that more and more people are becoming interested in it. And great for you for staying proactive and ahead of it. If folks have questions about this, I encourage you to reach out to Kevin, to talk a little bit more about it. 855-TWD-PLAN is the number. That’s 855-TWD-PLAN, or go online to truewealthdesign.com, and you can click on the “Are we right for you?” button and schedule a 15-minute call with an experienced advisor on the True Wealth team. Again, that’s truewealthdesign.com, and we’ll link to that in the description of today’s show, so it’s easy for you to find. Kevin, very good. Thank you for educating me on this topic. I know a lot of our listeners will appreciate it as well. And we’ll look forward to talking to you again on the next episode.

Kevin Kroskey:                  Thanks, Walter. I appreciate it.

Walter Storholt:               All right. Have a good one. That’s Kevin Kroskey. I’m Walter Storholt. And we’ll talk to you next time, right back here on Retire Smarter.

Disclaimer:                        Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical, and not an indication of future results. Benchmark indices are hypothetical, and do not include any investment fees.