Articles / 01.26.2020
I can’t stand losing any competition to my colleague, Matthew Weatherley-White, but he beat me to the punch by publishing his portfolio. I had been saying for at least two years that I would do so myself – particularly after I started receiving a lot of questions from industry peers about how I was investing my personal capital. Since none of them had a $10 million balance sheet (which is Caprock’s client minimum), they asked me how/where they might invest with impact. I pointed them toward Beth Bafford’s helpful article here and told them I’d soon write a similar article.
I apologize it’s taken so long – and want to make clear that this communication is not a solicitation or offer to sell investment advisory services. It is for informational purposes and does not constitute a complete description of available investment services. Please read our full disclosures here.
Note that I’ve divided my portfolio into the same six asset classes that we use at Caprock to segment the investable universe. Each one has different financial return expectations, performance drivers, liquidity profiles, etc., thereby enabling us to build out diversified portfolios that deliver consistent compounding of after-tax returns. But as I’ll note throughout the remainder of this blog, each asset class also has varying potential to drive social and/or environment benefits.
Cash & Cash Equivalents
This is where I frequently encourage impact investors to start. The simple reason is that deposits less than $250,000 enjoy full protection from either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). Community banks, credit unions, and development financial institutions have been driving impact by lending money to small businesses, individual borrowers, and nonprofits, within underserved and marginalized areas, for decades. Indeed, they were impact investors before impact investing was cool. And while some may suggest that community development financial institutions (CDFIs) accept heightened risk by serving these populations, 20-year studies demonstrate that they have financial track records every bit as strong as their conventional counterparts. As Antony Bugg-Levine (CEO of the Nonprofit Finance Fund) points out here, the community finance sector faces threats in the next decade – even more motivation, at least for me, to make this simple impact investment.
- Idaho First Bank: my wife and I moved our checking accounts to our state-chartered community bank shortly after we moved to Idaho in 2014. The main reason was because we wanted to “walk our talk” and keep our cash deposits as local as possible. And while our former bank (Wells Fargo) made it logistically difficult to sever ties, their ugly operations were figuratively impossible for us to stomach any longer. Full disclosure: if your community bank is anything like ours, it won’t offer the lowest mortgage rate, the highest interest rates on deposits, or the snazziest website. And there are certainly switching costs. But we trust our bank, which is something we couldn’t say before.
- Self-Help Federal Credit Union: we keep some cash in a money market and deposit certificate here because Self-Help is a one of the nation’s largest, most high impact CDFIs. Their investment products are used to support and finance small business lending, affordable housing, education finance, and other community development activities in California and Illinois (where my wife and I have both lived), as well as Florida, North Carolina, Wisconsin, and Washington, D.C. Full disclosure: while their rates are quite competitive with other credit unions, they are commonly a bit lower than those offered by Schwab and Fidelity. This is still the only asset class where the pursuit of impact necessitates a slight concession on financial return. But I’m comfortable accepting that in order to support such an exemplary organization like Self-Help.
- C-Note: First, I should point out that this is more of a “cash equivalent,” because it does NOT offer daily liquidity like your typical bank. In other words, if I want to make a withdrawal, I must give them a 30-day notice – and even then, I can only receive funds on a quarterly basis. Managing this kind of quirky liquidity can be a challenge for some, which is why I use this option in combination with Self-Help. The good news is that depositors in C-Note’s “Flagship Fund” receive an illiquidity premium: as of January 2020, their Annual Percentage Yield (APY) is 2.75%. (By way of comparison, Bankrate currently suggests that the best money market APY is 2.00%.) Add in the fact that these loans fund small business loans, affordable housing, and community development in low-income areas, and altogether, it’s an exposure that I’ve been quite proud to have in my portfolio for the last several years.
Admittedly, I don’t carry as much exposure to this asset class as one might argue I should. But the combination of historically low interest rates – and, correspondingly, the ongoing threat that those rates will rise, soon, one day (right?) – has compelled me to accept heightened concentrations to other asset classes. Put differently, I’ve been content to make trade-offs: I like the much higher impact offered by my investments in Cash and Alternatives, and I like the much higher financial returns posted by Public Equities. Note that at Caprock, we start the portfolio construction process with Fixed Income. Consequently, my personal approach to asset allocation is markedly different from my professional. But I’m a Caprock employee, not a client!
- World Bank Group – Sustainable Development Bonds: Confusingly, these are also known as IBRDs, which stands for International Bank for Reconstruction and Development. These are loans offered by the World Bank to governments of middle-income and creditworthy lower-income countries (Indonesia, Brazil, China, Mexico, and India are the top five). To quote the World Bank, this type of financing goes to countries who are working “to eliminate extreme poverty and boost shared prosperity, so that they can achieve equitable and sustainable economic growth in their national economies and find sustainable solutions to pressing regional and global economic and environmental problems.” Given their AAA credit and high impact use of proceeds, these bonds are one of my preferred Fixed Income holdings.
- Janus High Yield Bond Index (JAHYX): This is a small position within my 401(k). I only invested because I felt like I needed to accept some small exposure to this sub-asset class. This is one of the few holdings in my portfolio that is not values-aligned. The reason is simple: when I first allocated, there were no ESG high yield bond index offerings. As I’m writing this blog, I now see that Nuveen launched an ESG High Yield Corporate Bond ETF in September 2019. Maybe I’ll switch over to that, once their assets under management (AUM) gets to a level that can reasonably sustain the fund.
My hope is to one day move all my Public Equities over to Ethic. In short, they make values alignment easy and engaging, providing a solid estimate of how much tracking error an investor can expect as a result of their preferred screens. But for now, I hold stocks in far too many accounts (e.g., taxable, retirement, 529s, UTMAs) for it to make sense. Consequently, my Public Equity exposures are diffused across a variety of exchange-traded funds (ETFs) – almost all of which are low-cost and have an ESG overlay – as well as some select individual securities.
Unfortunately, since the ETFs are meant to mimic the performance of select benchmarks, all of them necessarily contain energy names I’d prefer not to own (e.g., Halliburton, Baker Hughes, BP…ugh). As you’ll see, I try to pick up as much geographic (domestic, international developed, and emerging markets) and stylistic (large, mid, and small caps; growth and value) diversification as possible. But this has been challenging, since there still aren’t a lot of low-cost ESG ETFs in certain niches. My expectation is that each ETF either minimizes those fossil fuel exposures as much as possible, or at least allocates to “best-in-class” actors, since I believe they will ultimately be detractors from long-term performance.
I guess I could (should?) own more climate-focused stock funds – perhaps those that expressly divest from any and all exposure to hydrocarbons, or that positively invest in companies whose products and services will make a material dent on carbon emissions. But those strategies tend to be actively managed, which is an investment approach whose returns have been empirically shown to be subpar when taxes and fees are included. We at Caprock generally eschew active management within this asset class, and in this domain, I’m squarely in alignment with my employer.
- iShares MSCI All Country World Index (ACWI) Low Carbon Target ETF (CRBN; 20 bps expense ratio; $500M AUM): This is my preferred vehicle for global large/mid-cap equity exposure, notably with much lower carbon exposure than that of the broad market.
- SPDR® S&P® 500 Fossil Fuel Reserves Free ETF (SPYX; 0.25% expense ratio; $473M AUM): A great option for domestic large cap stocks that has outperformed the S&P 500 since it’s inception in November 2015
- iShares ESG MSCI Europe, Australasia and Far East (EAFE) ETF (ESGD; 0.20% expense ratio; $1.5B AUM): A strategy that is much more targeted on large/mid-caps within international developed markets than CRBN. Vehicles like this and ESGE (immediately below) allow me to occasionally adjust my geographic weights in response to market conditions.
- iShares ESG MSCI Emerging Markets (EM) ETF (ESGE; 0.25% expense ratio; $936M AUM): Like ESGD, this fund offers targeted geographic exposure. Interesting side note: Cambridge Associates produced a study several years ago that showed ESG-based stock selection can add value in emerging markets. Anecdotally, we’ve seen the same – and it often has to do with governance, since corruption is so dilutive to shareholder value in some of these markets.
- Nuveen ESG Small-Cap ETF (NUSC; 0.40% expense ratio; $203M AUM): Again, another targeted stylistic exposure to small cap stocks, which is hard to obtain given the large-cap bias of many indexes. When I first invested, I believe this was the only ESG small-cap strategy – which is the only reason I was willing to pay the rather hefty expense ratio.
- Nuveen ESG Large-Cap Value ETF (NULV; 0.35%; $132M AUM): This is a recent addition, partly because I had avoided value stocks for years, and partly because there wasn’t an ESG value-focused strategy. The expense ratio is still higher than I’d prefer to pay, but I felt compelled to add it given the current outlook for value stocks.
- Vanguard ESG US Stock ETF (ESGV; 0.12% expense; $946M AUM) Another new-ish fund (it debuted in September 2018) – this time, from the low-cost ETF leader. Given that its performance has been virtually identical with SPYX since its inception, I’ll likely starting using this lower cost, all-cap strategy rather than SPDR’s option.
- Goldman Sachs U.S. Large Cap Equity ETF (JUST; 0.20% expense ratio; $125M AUM): I figured I’d give this strategy a try after it made a big splash back in the summer of 2018. I suspect I’ll swap it out soon, since performance has lagged a bit…and, in prepping for this blog, I just realized that the AUM is now only 50% what it was when it debuted on the NYSE Arca exchange.
- iShares India 50 ETF (INDY; 0.94% expense ratio; $805M AUM): For this strategy (and the remaining three exposures), I decided years ago to make concentrated investments that are unhinged from my impact passions. India’s growth potential offers a lot of appeal – and I can only hope that they find a way to do so in a more sustainable manner.
- Invesco QQQ Trust (QQQ; 0.20% expense ratio; $90B AUM): I’d never attempt to argue that this is a values-aligned strategy. In many ways, I think the tech industry has exacerbated the income inequality that some of my Cash exposures are trying to ameliorate. So this holding is a bit of a contradiction for me.
- Alphabet Inc (GOOG): “Don’t be evil,” amirite? Arguably, there’s only a few other companies that stir so much passion amongst investors. I understand Google’s criticisms, but firmly believe the corporation is doing some interesting things with its Moonshot Factory.
- Amazon (AMZN): This company just topped Slate’s “Evil List” (though I’d argue Facebook and Twitter have had a much more destructive societal impact). I wondered a few years ago why the company would fight a shareholder proposal that sought diverse candidates for their board. And I cringe at the waste I’ve created every time I open one of their packages. Argh, another contradiction.
The goals for investments within this asset class are 1) low volatility, 2) returns uncorrelated from any other asset class, and 3) decent liquidity. The minimums can be prohibitively high for me, which is why I only have one exposure.
- TriLinc Global Impact Fund: I loved the way this strategy intended “to bring impact investing to Main Street.” Its minimum investment ($2000) was meant to attract retail investors, thereby supporting the growth of our industry. The fact that it supports financial inclusion for small- and medium-sized enterprises in developing countries was also appealing. Of course, trade finance has its critics. But TriLinc’s commitment to driving – and quantifying – their social benefit, when combined with the fund’s steady income, has made it one of my favorite investments. (Unfortunately, the public offering closed back in March 2017, so this is one of two investments in my portfolio that is no longer available.)
These are typically hard assets, such as real estate, timberland, or operational infrastructure. The goal is generally to produce a varying combination of income (e.g., rents, in the case of a multifamily property) and capital appreciation (e.g., from an eventual sale of the apartment). Again, the returns should be uncorrelated from those of the other asset classes. And again, sadly, I probably don’t have as much exposure here as I should.
- Greenbacker Renewable Energy Company: Greenbacker owns and operates a large, diversified portfolio of renewable energy assets across the country. These solar, wind, biomass, and other assets generate reliable power, which is then sold off to high credit-quality counterparties via long-term power purchase agreements. The income receives favorable tax treatment, and the expectation is that Greenbacker will soon sell the entire portfolio at a premium. Meantime, I’m directly contributing to the generation of renewable energy. (Sadly, they closed their public offering a year ago, in January 2019.)
I don’t hold any of these venture capital or private equity offerings (yet!), which is a disappointment for several reasons. First, they tend to have the highest expected returns (albeit with the highest volatility as well). Second, because in my former role at Investors Circle, I was introduced to some amazing early-stage entrepreneurs who have since gone on to scale their companies in an impressive manner. The third reason is because I firmly believe that while values-aligning investments in stocks and bonds are nice, the most tangible social and environmental benefits are catalyzed via private market transactions. Fourth and final, it is in this asset class that Caprock delivers significant value for its clients. We have access to top tier managers who have frequently demonstrated their ability to generate alpha for their limited partners. The only problem is that the minimums are prohibitively high for me…for now. But if my impact portfolio keeps chugging along like it has over the last decade, who knows?