Over the past several years, a growing number of investors have shown an interest in putting their money where their values are, steering them away from certain investments that they view as polluting (e.g., oil and gas companies), endangering (e.g., gun manufacturers or tobacco), or sinful (e.g., casinos or alcohol). Instead, these impact investors seek out shares in companies that are green, safety-promoting, and socially-responsible.
It is perhaps no surprise that social-responsible investing (SRI) is especially popular among younger generations, like the millennials. Technology-heavy robo-advisors such as Betterment and Wealthfront have started to offer SRI portfolios to appeal to these investors. Here, we will consider the various ways that a robo-advisor can help with impact investing.
Key Takeaways
- Impact investors seek out shares in companies that are green, safety-promoting, and socially-responsible.
- Many robo-advisors now seek out exchange-traded funds (ETFs) that specialize in SRI and ESG investments and optimize portfolios in such a way as to approximate what modern portfolio theory would otherwise dictate.
- Socially responsible and ESG investing are gaining traction, especially with younger investors who also may be attracted to the technologically-focused investment platforms that robo-advisors provide.
SRI and ESG
There are several frameworks that have arisen to address the desires of impact investing. Environmental, social, and governance (ESG) criteria are a set of standards for a company's operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights.
Socially responsible investing, also known as social investment, is an investment that is considered socially responsible due to the nature of the business the company conducts. Socially responsible investments ignore companies that produce or sell addictive substances (like alcohol, gambling, and tobacco) in favor of seeking out companies that are engaged in social justice, environmental sustainability, and alternative energy/clean technology efforts.
There are two inherent goals of socially responsible investing: social impact and financial gain. The two do not necessarily have to go hand in hand; just because an investment touts itself as socially responsible doesn't mean that it will provide investors with a good return, while the promise of a good return is far from an assurance that the nature of the company involved is socially conscious. An investor must still assess the financial outlook of the investment while trying to gauge its social value.
According to a 2022 report from the U.S. SIF Foundation, investors around the globe held $8.4 trillion in assets chosen according to socially-responsible criteria. This represents 12.6%, or $1 - $8, of the $66.6 trillion in total U.S. assets under professional management.
Impact Investing With Robo-Advisors
Robo-advisors are algorithmic investment platforms that automate and optimize portfolio choices for individual investors with low costs and minimal human involvement. Traditionally, robo-advisors follow the logic of modern portfolio theory (MPT) to optimize a diversified portfolio across several asset classes and a philosophy that indexing is the best strategy for most investors. Indexing, however, implies that every stock in an index be held at its given weight in that index. Therefore, index investors will undoubtedly end up holding shares in companies that are not SRI or ESG-friendly.
To solve this issue, many robo-advisors now seek out exchange-traded funds (ETFs) that specialize in SRI and ESG investments and optimize portfolios in such a way as to approximate what modern portfolio theory would otherwise dictate.
The best robo-advisors can improve SRI investing for many investors that are doing it themselves: Some investors buy SRI funds that carry high management fees or sales loads, while robo-advisors seek out low-cost ETFs. Others screen for SRI stocks in such a way that they forgo the benefits of proper diversification against risk. These investors pick their own basket of SRI stocks, which can be a challenging and time-intensive approach. Robo-advisors can also automate portfolio rebalancing and engage in tax-loss harvesting to minimize tax exposure for investors.
What SRI Approaches Do Robo-Advisors Use?
Each robo-advisor approaches SRI and ESG portfolio construction a little bit differently. Some platforms, like Earthfolio, only have SRI investment options and nothing else. Here, we will briefly describe some of the strategies used by popular broad-based robo-advisors:
Betterment
Betterment seeks out SRI funds for U.S. large-cap stocks and emerging markets stocks only. According to their website, "Other asset classes, such as value, small-cap, and international stocks and bonds, are not replaced with an SRI alternative in our portfolio either because an acceptable alternative doesn't yet exist or because the respective fund's fees or liquidity levels make for a prohibitively high cost to you, our customers." Therefore the stocks, but not bonds, of companies like Exxon Mobile, Chevron, and Philip Morris may be excluded. The ETFs that Betterment uses in their SRI portfolios included CRBN, ESGU, SUSA, and ESGE as of 2023.
Wealthfront
Unlike Betterment, which identifies SRI ETFs, Wealthfront allows certain users to instead restrict which companies they do not want to invest in. According to the company's website, "If you currently qualify for U.S. Direct Indexing, you can tell uswhich individual companies you do not wish to invest in using the restrictions list in your settings."
Empower
Empower (formerly Personal Capital) is intended for higher-net-worth individuals, with a minimum opening balance of $100,000 to get started. For those customers, Empower does offer SRI portfolio options. Similar to Betterment, the ESG components only apply to ETFs chosen for U.S. equity components of their portfolios. The rest of the asset class components rely on traditional ETFs and funds. But what is unique, however, is that Empower itself selects the stocks it deems most appropriate and earn the highest ESG scores for that equity component, which they claim provides a higher level of "best-in-class" ESG stocks than ETFs.
Wealthsimple
Wealthsimple takes a more complete approach to SRI investing, utilizing ESG-optimized ETFs for both equities and fixed income components and splitting these up by criteria. For instance, they use one ETF that invests in global stocks while excluding companies focusing on fossil fuels, tobacco, and weapons. On the bonds side, they seek out municipal bonds issued by local or state governments and short-term corporate bonds that have socially-responsible values. Wealthsimple uses their proprietary ETFs, which include WRSI, WRSD, and WSGB.
Ellevest
Ellevest is the robo-advisor specifically intended for female investors. It is no surprise then that Ellevest includes funds that support growing small businesses owned by women and other underrepresented populations in its impact portfolios—in addition to more traditional ESG-focused ETFs.
How have Robo-Advisors Evolved to Accommodate the Rise of Impact Investing?
Robo-advisors have evolved to accommodate the rise of impact investing primarily by incorporating environmental, social, and governance (ESG) criteria into their algorithmic portfolio management systems. Some robo-advisors use ESG-optimized exchange-traded funds (ETFs), while others allow investors to personalize their portfolios by excluding certain companies. The goal is to align investors' financial objectives with their ethical or social values, providing an easy, low-cost way for individuals to engage in socially responsible investing (SRI).
What are the Main Considerations for Investors who are New to Socially Responsible Investing (SRI)?
New investors considering SRI should first understand the fundamental principles of socially responsible investing and ESG (environment, social, governance) criteria. They should be aware that these investment strategies strive to combine financial returns with social/environmental good. It's also important for them to recognize that while SRI and ESG funds generally aim to have a positive impact, the performance of these funds can vary, just like any other investment.
Can Robo-Advisors Effectively Balance Both Social Impact and Financial Gains in their SRI and ESG Portfolios?
Yes, robo-advisors appear to effectively balance both social impact and financial gains in their SRI and ESG portfolios. Robo-advisors typically utilize algorithms and proven investment models to create a diversified portfolio that aligns with an investor's risk tolerance, financial goals, and ethical values. However, it's important to understand that by limiting the universe of available securities to those that score highly for SRI/ESG, investors will not be able to achieve full-diversification that would otherwise have included non SRI/ESG compliant stocks and other assets.
Is the Trend of Socially Responsible Investing Likely to Influence the Future Development of Robo-Advisory Platforms?
The trend of socially responsible investing is indeed likely to influence the future development of robo-advisory platforms. As more investors show interest in aligning their investments with their ethical values, robo-advisors are likely to continue to adapt their algorithms and offer more personalized options to cater to these preferences. They may also incorporate more nuanced or industry-specific ESG criteria, offer more educational resources on impact investing, or even partner with nonprofit organizations or social enterprises to further enhance their social impact.
The Bottom Line
Socially responsible and ESG investing are gaining traction, especially with younger investors who also may be attracted to the technologically-focused investment platforms that robo-advisors provide. Several robo-advisors now offer socially-responsible or impact investing portfolios alongside their more traditional diversified index portfolios. While we only profile a few here, many more robo-advisors are beginning to include ESG funds in order to meet the demands of their users.
