According to Schwab’s Modern Wealth Survey, 73% of Americans say their personal values guide how they make life decisions more today than they did two years ago, and 69% say that supporting causes they care most about are a top consideration when it comes to their financial decisions. In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Luke Wilcox, founder of Ethos ESG, a FinTech platform for financial advisors, investors and institutions to align money with causes they care about, including racial justice, climate change, LGBTQ equality and more.
In this episode, you will learn:
- What is ESG investing, in a nutshell?
- Perspectives on the rise of values-based investing.
- How Ethos ESG’s platform works to align people with their purpose.
- How companies like Ethos ESG measure the impact of values-based investing.
- What to look for in the future of ESG and values-based investing.
- And more!
Disclosure: The transcript below has been lightly edited for clarity and content. It is not a direct transcription of the full conversation, which can be listened to above.
Welcome back to The Agent of Wealth Podcast, this is your host, Marc Bautis. On today’s show, I brought on a special guest, Luke Wilcox. Luke is the founder of Ethos ESG, a platform for investors to align money with causes they care about. Luke, welcome to the show.
Thanks, Marc. It’s great to be here.
ESG investing isn’t new, but I think we’re seeing more interest in it. More people want to invest with their values. Can you start off by providing a little background on what ESG is? What does it mean to invest with your values?
ESG Investing in a Nutshell
ESG stands for environmental social governance. As you mentioned, it was introduced a long time ago. Historically, ESG investing has focused on measuring the sustainability and ethical impact of an investment in a business or company. For example, mitigating downside risk by avoiding investments that are exposed to fossil fuel, or avoiding investments that don’t have good governance.
There’s also another side of ESG investing, which is values-based investing. Values-based investing, or socially responsible investing, is more about aligning your money with your values. A lot of investors generally associate values-based investing with ESG investing.
The process of aligning your investments with your values often takes form through negative screening. In this process, an investor starts with the entire universe of potential investments, then screens out variables that don’t align with whatever it is they care about, like fossil fuel impact. That’s the basic approach to ESG investing.
Investors can also look at a business or company’s ratings to see which are aligned with the impact they want to have in the world. This is a growing part of ESG investing, and an area that we’re really focused on at Ethos ESG – the impact of values-based investing.
Perspectives on the Rise of Values-Based Investing
Great. So we see this trend is increasing, right? I think it’s due to education, for one. For a while, people didn’t know they could invest this way. But another reason is because we’re in such a politically charged environment right now. People are interested in influencing change. You can do this by voting and protesting. If you have a lot of money, you can lobby and create influence that way. But for the majority of people, they can create change through investments – big or small. Put your money towards something you believe in. Are there any other reasons you see for this trend picking up?
Voting is a good analogy. For some, it may seem like a relatively small values-based investment doesn’t have much of a direct impact. But if a whole bunch of people are doing that, and it moves capital away from fossil fuel, for example, that can have a real impact. It’s similar to voting in that way, as voting can affect real change when more people vote the same direction. Along those same lines, people are seeing tangible effects of climate change, social movements, etc.
People are feeling the real impact of broad trends in the world, and they’re searching for ways to respond to them. For example, if you experience a forest fire, taking action against climate change could hit home. Investors can do that with their money.
Lastly, I would say there’s an increase in shareholder advocacy, because now you can engage directly with any companies or funds you hold as a shareholder. There’s an increase in tools and resources out there that make it easier to affect change in companies (or funds) you’re invested in.
When you mentioned people banding together, it reminded me of the meme stocks surge, due in part to Reddit. Of course there were institutions behind meme stocks, but it’s an example of investors banding together – there is power in numbers. What was the impetus for you to start Ethos ESG?
Founding Ethos ESG
Personally, I was really dissatisfied with the analysis out there for retail investors, larger investors and wealth managers in regards to the values perspective. I was trying to find credible analysis on what the real impact of my investments were on the things that I care about, from climate change to social justice, and so on.
When I founded Ethos ESG in 2019, there were not a lot of great resources that combined data in a credible, meaningful way, allowing investors to determine how aligned a particular investment is with their values. Still today, a lot of the ESG information focuses more on financial risk. Whereas I, and a lot of investors, are really interested in measuring the impact. That’s what drove me to found Ethos ESG.
The fact that Ethos ESG can provide that information is great. So let’s say there are 50 different filters based on ESG characteristics. Can the Ethos ESG technology specifically filter each, to create a personalized profile for investors?
So our platform focused on letting the end investor – directly, or through a wealth manager – selecting five to 10 issues they care most about. Some examples are climate change, biodiversity, social justice issues, ending world hunger, mental health initiatives… Whatever is most important to you, we help you pick those things. Then you can screen things out. For example, let’s say you don’t want to invest in any alcohol, or fossil fuel.
We personalize the criteria to build a basket of available securities. That’s the ESG basic methodology: starting with the universe then filtering down based on your criteria to a smaller basket of potential investments, companies or funds that you can then consider engaging with.
Is there a way to do it the other way? Let’s say an investor wants to filter in specific things that they care about?
You can, yes. On Ethos, you can start with, say, the top 10 companies rated for gender equality. Or you can start with a sector or industry, then get the top-rated on a particular issue. In these instances, we start with the top-rated across a diverse sector allocation, then build a portfolio from that.
Does Ethos ESG use its own ratings, or ratings from somewhere else?
That’s a great question. There’s a lot of debate about ratings because there’s no standard rating system. Each rating agency has a different answer for the same company. It’s really confusing and frustrating for a lot of investors. For example, Morningstar may rate a company well and MSCI may rate the same company poorly. At Ethos ESG, we don’t use any external ratings. We create our own. But I have a lot of respect for the other ratings agencies.
We really focus on impact, or values alignment, first. We don’t consider risk or financial materiality in our ratings. Our focus on impact leads to different metrics, different data sources, different weightings of underlying data points. We underweight self-reported data from companies, because we believe that there’s a lot of issues with lack of standard reporting. We try to prioritize what is going to let us assess the impact of a company or fund, on whatever cause the investor cares about.
Measuring the Impact of ESG Investing
That makes sense. When I approach people about ESG investing, there’s three reactions. One, people say, “This is great, let’s do it.” Two, people say, “I don’t care about values in my investments.” And three, there’s people in the middle, who say, “This is interesting. I think I’d like to do this, but how will my investments perform if I take this approach?” Do you know of any statistics that show how ESG investments do relative to non-ESG types of investments?
There’s been a lot of studies on this over the last 30-40 years. I’m forgetting the actual name of the meta analysis, I apologize, but there was one that looked at about 1,500 studies over the last 30 years. It found that 90% of them did not find a negative correlation between ESG scores and financial performance. About 40% found a positive correlation, about 50% found a neutral or non-significant correlation and about 10% found a negative correlation. There’s more statistics out there, but I think you can’t make a blanket statement. It depends on what particular data you’re using for what particular industry.
For example, if you’re looking at environmental data for an energy company, you have to consider materiality. Ratings are going to be most material to a company’s financial performance. If you get to that level of detail, then I think you can draw some interesting conclusions, but it is hard to draw any blanket conclusion.
Is there a way to measure the impact of ESG investing on values, like climate change?
Yeah, that’s a great question. We look at data and try to equate it to some kind of real-world metrics, like fewer cars on the road or fewer miles driven. It can seem very indirect at times, but you are really having an impact on a company’s performance through making investment selections.
Back to how Ethos ESG filters companies, what happens if a company falls on both sides? Let’s use energy as an example. What happens if a company is into oil, but also an enormous investor in clean energy as well. Do they automatically get excluded because of what they’re doing with oil?
Well it’s not just a straight exclusion or inclusion. Within one category, such as environmental, there’s a distribution of impact across causes or issues. So an oil and gas company could have a negative impact on the environment, but maybe they treat their employees really well, or have an incredible governance structure. At Ethos ESG, we try to show the full distribution of impact across causes.
Values-Based Investing Across the Entire Political Landscape
When I initially introduced the topic of ESGs, I talked about the politically charged climate we’re experiencing right now. Are there opportunities for values-based investing on both sides of the political aisle?
Yes, definitely. We are apolitical, so we offer more faith-based screens or things that would be more so on the conservative side of the political spectrum. We’re trying to enable values-based investing, no matter what those values are.
Great. You mentioned the optimizer. Can you go into a little more detail on how that works?
Yeah, definitely. It’s designed to maximize impact on the personalized causes that are most important to you, while matching the back-tested performance of some index or blended benchmarks. You can choose multiple indexes, while also fitting any other criteria you want – number of stocks in your portfolio, for example.
First, you select an index (or multiple) that you want to match the financial performance of in backtesting. Second, you set tax preference criteria, like if you’re trying to harvest tax losses or realize tax gains. Step three is really where Ethos ESG’s optimizer is different. It allows extremely personalized impact preferences. Out of the 45 ESG causes that we track, you can pick whatever number you want and rate from one to seven based on what’s most important to you. Then, we’ll rate every potential company and every potential stock in that index – or multiple indexes – on that mix of causes. We try to maximize the impact on those causes. We’ll also let you screen out things.
The optimizer takes that universe and then, based on the past 10 years performance, it tries to minimize the variance between returns for your model and returns for that index or blended indexes. You can set the threshold of that variance between the returns on the index and returns in your portfolio, to as tight of a variance as you want. So it’s matching the financial performance and it will iterate through many, many thousands of potential combinations to reach whatever criteria you’ve set.
We partnered with Morningstar to offer this optimizer at a really low cost. It’s a flat fee to start out, for financial advisors and wealth managers to use with their clients. It’s intended to enable people to create very personalized portfolios that match both values and the risk return profile they want.
Is it a subscription service for financial advisors and wealth managers?
It’s a flat, single price with unlimited usage. Financial advisors and wealth managers create as many reports as they want. There’s typically a 200-400 client limit within the base levels, but we can raise those levels. For an annual fee, the base levels are either $2,000 or $4,000/yr.
What to Look for in the Future of ESG and Values-Based Investing
What’s new in the ESG space? Where do you see things going?
I see the values-based side continuing to grow. When investors think about ESG investing, they’re usually thinking about financial risk mitigation more than thinking about the impact on things that they care about. I think there’s going to be much better information available for investors about the real impact, leading to better ways to take control of what they value.
I also think there’s going to be more regulation and requirements for reporting by companies and fund managers. This will really benefit investors. The more standardized reporting there is, the better decisions we can make about which companies are aligned with our values.
Makes sense. Well, we’re just about out of time. Luke, I want to thank you for being on the show. You gave some great info on how investors can allocate their money, based on their values. How best can someone reach out to you if they want to find out more information about Ethos ESG and what you do?
Great, we’ll link to all that in the show notes. Thanks again, Luke. And thank you to everyone who tuned into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.