How to Be Sustainable Across All Assets in Your Portfolio

20th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here. A HIP investor can find human impact and profit potential in every type of investment. Formally, these are called asset classes, and you want a diverse mix of them in your portfolio. Each investment category or “class” has a different risk and return profile. Asset class choices that have higher risks seek to reward investors with higher returns. Each investor has varying tolerance for risk. Portfolios can have a mix of high and low risk, which each expect a higher or lower return. A HIP Portfolio seeks to lower risks across all categories, especially those associated with long-term issues like managing health and wellness and ecological sustainability. A HIP Portfolio of equities also seeks to deliver higher than expected returns than the S&P benchmarks. Specifically, the HIP 100 Portfolio competes against the S&P 100 benchmark; the HIP100 re-weights the same equity components based on quantitative sustainability criteria, which tend to be leading indicators of financial performance. The latest performance (and disclosures) of the HIP100 can be found here. In finance terms, if all asset classes realized lower risk or higher return by being allocated in a HIP way, the results could be a more optimal “efficient frontier” of choices for investors. Basically, an investor who assembles portfolios that are “more efficient” could experience more gains or lower risks. And HIP investors always seek to increase the net positive human impact of their investments. Determining allocations for your portfolio In excerpting the HIP book so far, we have focused on how to evaluate investments for the equity portion of your portfolio. When investing for long-term goals like retirement or your newborn’s college tuition, equities tend to deliver some of the highest returns relative to other choices for your portfolio. The table below shows the typical risk and return ranges of varying asset types including equities, bonds, government Treasuries, and cash. From 1926 to 2005, Ibboston’s database of stocks, bonds and inflation has calculated average annual returns and the annual volatility (risk) realized. Consumer inflation has averaged 3.0 percent over this period, which has offset most of the average annual 3.7 percent returns from U.S. Treasury bills. Medium-term government debt (typically 10 years) has averaged 5.3 percent returns, and longer-term government debt (30-year duration) has returned about 5.5 percent annually during these decades. Long-term corporate bonds average a return of 5.9 percent over this multi-decade time frame, with slightly lower volatility than U.S. government bonds. The highest returns—and highest risks—come from stocks: large-company stocks have averaged 10.4 percent annually, and small-company stocks have produced 12.6 percent annual returns on average in this time. Any year’s returns can vary widely around this average. Hence, investors must be conscientious about their time horizon and when these investments will be needed. Depending on the timing of when you invest, these returns can vary significantly. An attractive decade was the 1950s, when U.S. corporations led the rebuilding of European infrastructure after World War II. A “lost” decade for equity returns was the volatile 1970s, with spikes in oil prices and multiple recessions. The year 2008 resulted in much strife among investors as the prices of nearly all types of investments fell at the same time—which is an unusual event for a diversified portfolio. The 2000–2009 decade was not kind to equities either, especially after adjusting for inflation. While you can’t control the performance in each decade, or certainly by year, you can select a diversified HIP approach that seeks to better manage your risks and expected returns, with more positive net impacts of your portfolio. In the next section, we will examine a more comprehensive approach to target “doing good” for your portfolio and the world. Investment choices beyond public equities While we discussed public equities in our previous article, this feature will focus on additional investment classes. There are many other choices in how you can invest in a HIP way besides how you allocate among your public equities. A HIP investor can consider a mix of investment options to best match their risk profile for the goals and objectives for financial return and human impact for their portfolio. There a variety of investment choices – Cash, Fixed Income, Private Equity and Venture Capital, Real Estate and Forestry, Commodities, and Tax-Deductible Charity – which allow you to manage your level of risk and diversity in your portfolio. It also allows you to seek out and support companies working to solve human needs within a profit-based model. Furthermore, it gives you, as the investor, a chance to construct a highly personalized portfolio that authentically engages your many interests and directly relates to your daily life and flow of money. Cash Do you know where the cash in your bank or money market goes? Most of us know that it goes to loans, but not the particular borrower types. For example, New Resource Bank in San Francisco uses customer deposits to finance green businesses and clean-tech companies that are working to make their operations more sustainable (See example borrowers here: https://www.newresourcebank.com/content/who-we-finance .) New Resource Bank also offers a “planet smart” debit card with every checking account, which earns donations for nonprofit partners. In our next feature, we will share more examples for “parking” your cash – but ask your bank or credit union, “where does my money sleep at night?” Fixed income and loan funds As with any loans or bonds, these tend to be lower risk in comparison to equities, but are not immune from risk. Two types to consider for an impact-focused portfolio are pooled loan funds, and microfinance funds. Pooled loan funds RSF Social Finance (RSF), (www.RSFsocialfinance.com) based in San Francisco, is a nonprofit financial services organization that offers investing, lending, and giving options for its clients. Among its offerings for investors, RSF manages two loan funds, one is accessible to all investors (RSF Social Investment Fund) and another is mainly targeted at high net worth investors (RSF Mezzanine Fund). There is a purposeful drive by RSF to make loans to organizations that “improve the well-being of society and the environment.” In the loan-process evaluation, RSF highly values firms with sustainable design of products, a fair-trade production system, and even a “capital structure and existing financial partners that reflect commitment to social good and environmental sustainability.” Microfinance funds “Microfinance is an ingenious idea because, in a way, it acts as the Federal Reserve for entrepreneurs globally,” says Jim Torrey, a professional investment fund manager. “If you look at the numbers, they are really extraordinary—the number of jobs created and people helped. I love the fact that microfinance is not a handout, but enables individuals to take ownership of their lives and become independent and entrepreneurs.” Torrey is an investor in microfinance, and also the Board Chair of microfinance fund MicroVest (http://www.microvestfund.com/), based in Washington D.C. Other for-profit examples include Prosper.com founded by Chris Larsen and MicroPlace.com founded by Tracey Pettengill Turner, now a business unit of PayPal and eBay. Private equity and venture capital John Doerr is a managing partner at the legendary venture firm Kleiner Perkins Caufield Byers, which funded Google, Amazon, Intuit, and Sun. The firm has established a $500 million Green Growth Fund to fund growth-phase companies in green technologies, information technology, and life sciences. “We urgently need to advance our green-tech industry at a speed and scale commensurate with the challenges we face,” said Doerr in 2008. “We believe green technologies are both the key to solving our energy crisis and a tremendous business opportunity.” Another example is the Patient Capital Collaborative, a venture capital fund initiated by the impact-focused Investors’ Circle network, which recently merged with SJF Institute. Real estate Another potential allocation for a HIP-focused portfolio is investments in real estate and forestry, which can offer interesting opportunities for increased human impact and profit. For many investors, this starts with your house (the asset) and how you finance it (the liability). If you own a house, you have diversified your portfolio. Historically in the United States, this was one of the best savings and investment vehicles that also benefits from the tax deductibility of mortgage payments. To increase your portfolio’s HIP factor, you might consider an energy-efficient mortgage (EEM). Created by President Jimmy Carter’s executive order in 1979, these mortgages allow homeowners to take credit for energy savings in the calculation of how much home you can afford, by adding the energy savings onto your income. Ask your bank or credit union if they offer these more HIP mortgage options. Last year, HIP came out with our new Sustainable Real Estate Portfolio, where we select from a universe of approximately 200 Real Estate Investment Trusts (REITs), and also includes national resource, forestry, and timber companies, as categorized by Morningstar. This real estate portfolio is scored for sustainability, including results from LEED-certified properties, which can generate savings from consuming less water and reducing energy usage. Check it out HERE! Commodities Did you know you could trade the weather? Actually, you can buy a contract about a weather prediction related to how many cold or hot days there might be in a future month. Utilities purchase these to hedge their risk of making less money due to weather events. It is not technically considered insurance (which covers low-probability events) but rather called a “derivative.” A more tangible example is the trading of commodities like corn, orange juice and coffee. What would you pay for guaranteeing that those food and beverages were raised in a healthy way with no chemicals, or that the farmers were paid a fair wage? Today, that does not yet exist in the commodities or futures markets—but it could with increased information transparency about farming methods. Look out for these in the near future, with companies like PepsiCo’s Tropicana orange juice unit, Starbucks’ coffee purchases and Whole Foods’ grocery positioned to be active traders in those more HIP commodity contracts. Today, contracts trading carbon-credits trade among companies as well as private exchanges like Missions Markets. Currencies and Sovereign Debt As you diversify globally, how HIP are the practices of the countries where you invest? Does your investing support positive environmental and social impact in China, India, Brazil, and South Africa? While there are stock exchanges of socially beneficial companies in Brazil and South Africa, there is no HIP adjustment for currencies. However, currency values fluctuate depending on risks linked to political systems (open democracies vs. closed dictatorships) and economic policies (protectionism vs. free trade) among other factors. EIRIS, a global provider of independent research into the environmental, social, governance (ESG) and ethical performance of companies, is expanding its research into the practices and policies of foreign countries – so that they could be used to rate and rank sovereign debt. In total, EIRIS is using more than 60 indicators for each country including: governance (“is death penalty still used?”), spending on health and education, and the level of civil rights. Similar information can be found in the United Nations Human Development Index. Tax Deductible Charity Some charitable models may not lend themselves to economic self-sufficiency. You probably do not want human rights to be a tradable commodity—but rather a set of rights to which we are entitled, like respect and dignity, as well as access to clean water and affordable health care. Organizations that find, fund, and support forward thinking entrepreneurs (mainly non-profit but increasingly for-profit) solving social problems include Ashoka, Echoing Green and the Draper Richards Foundation. They each support the concept of entrepreneurial leaders creating high human impact in a systems changing and strategic approach. Kiva.org is a great example where donations to non-profits can have a compounded impact. Launched in 2005 by Matt Flannery and Jessica Jackley, the cofounders wanted to make it easier for borrowers and lenders to find each other. Today, a tax-deductible donation as low as $25 provides capital that is loaned to a micro-entrepreneur that the donor can select, and then when repaid, that capital can be reloaned. This produces an economic and impact multiplier effect that can last for years, which is very HIP. In addition, donors can choose how much to add on to their donation to support Kiva. Planning Your More HIP Choices in Detail Throughout all these different asset classes you can begin to see how it is possible to create your portfolio into something that accurately represents your care for human impact and HIP’s five elements: Health, Wealth, Earth, Equality, and Trust. In the forthcoming features we will delve deeper into each asset. Next time, we will explore where to “park” your cash and how your funds can generate human impact as well as seeking profit. To navigate this series, please use this table of contents. *** HIP Investor supports Spring of Sustainability.  For three months, the Spring of Sustainability will feature 100 “stars” of sustainability, from Jane Goodall to Bill McKibben to Van Jones, in free interactive teleseminars throughout the spring of 2012. Live events will also be held in cities across the globe. *** R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois. NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com Follow on Twitter @HIPInvestor