Artifex Guide to Successful ESG Investing

A Guide to Successful ESG Investing

Doug Kinsey, CFP® , CI M A®

C o - Fo u n d e r a n d C h i e f I n v e s t m e n t O f f i c e r A r t i f ex Fi n an c i al G r o u p

Artifex ESG presents | A Guide to Successful ESG Investing

"I've always loved nature. But I didn't really start to care about the environment until I became a fly-fisherman."

"Being outdoors, hiking through forests and fields, and wading the rivers has impacted my thinking about our world and how we should be good stewards of it.

When it comes to my personal investments, I'm a little more critical of companies that don't exhibit a stewardship attitude toward the environment, their employees, and society in general. In short, I am an ESG investor, and you can be as well."

Doug Kinsey, CFP®, AIFA®, CIMA® Chief Investment Officer

Artifex ESG presents | A Guide to Successful ESG Investing

About Artifex ESG

04

Introduction

06

Identifying your preferences

07

Investment analysis

09

Conclusion

14

Resources

16

Artifex ESG presents | A Guide to Successful ESG Investing

About Ar t i f ex ESG

Artifex ESG presents | A Guide to Successful ESG Investing

It's exciting when a client's values can be successfully matched up with investments that he or she can feel good about, and when the portfolio shows strong performance over time.

Ar t if ex ESG is an ar ea of con cen t r at ion w it h in Ar t if ex

m at u r ed, w e've been able t o iden t if y best -in -class

Fin an cial Gr ou p, a f ee-on ly Regist er ed In vest m en t

in vest m en t opt ion s t h r ou gh m or e advan ced scr een in g

Advisor an d f in an cial plan n in g f ir m f ou n ded in 2006 by

t ools an d t ech n ology. We n ow f eel con f iden t in sayin g

Dou g Kin sey, CFP®, AIFA®, CIM A® an d Dar r en Har p,

t h at you can in t egr at e you r per son al valu es in t o you r

AIF®. Ar t if ex w or k s w it h over 220 in dividu al clien t s

por t f olio an d n ot sacr if ice in vest m en t r et u r n s. For

an d cor por at e 401(k ) plan s t h r ou gh ou t t h e Un it ed

m or e in f or m at ion on ou r f ir m , go t o

St at es, an d h as t h r ee of f ices in t h e st at e of Oh io.

We st ar t ed cr eat in g En vir on m en t al, Social an d Gover n an ce por t f olios in 2014 af t er w it n essin g in cr eased dem an d f r om ou r clien t ele. Th is h as been n o an om aly. Accor din g t o USSIF: Th e For u m f or Su st ain able an d Respon sible In vest m en t , as of year -en d 2015, on e ou t of ever y f ive dollar s u n der pr of ession al m an agem en t in t h e Un it ed st at es - $8.72 t r illion or m or e-w as in vest ed accor din g t o SRI st r at egies. Addit ion ally, as t h is t ype of in vest in g h as

w w w.ar t if exf in an cial.com / ar t if ex-esg.

Artifex ESG presents | A Guide to Successful ESG Investing

"Sustainable investors aim for strong financial performance, but also believe that these investments should be used to contribute to advancements in social, environmental and governance practices. " --USSIF Th er e ar e m an y t er m s f or t h is t ype of in vest in g -

lar ge Wall St r eet f ir m s t o sm all bou t iqu e sh ops

Su st ain able, Respon sible, Im pact (SRI); En vir on m en t al,

w it h t h eir ow n m u t u al f u n ds. M an y do n ot h ave

Social & Gover n an ce (ESG); Im pact in vest in g; Valu es

a ver y lon g or con sist en t t r ack r ecor d an d som e

In vest in g; Fait h -Based In vest in g; " Gr een In vest in g" et c.

ar e ESG in n am e on ly.

We ch ose ESG as ou r f ocu s, as it r epr esen t s t h e

-

Mutual Funds or ETF's may not adequately reflect

br oadest cr it er ia t h at ou r clien t s an d ou r t eam ar e

your personal preferences - I r ecen t ly r eview ed a

m ost in t er est ed in . Im pact in vest in g is a sim ilar t er m ,

n ew " SRI" Exch an ge Tr aded Fu n d (ETF)

bu t can im ply a m or e act ive st yle of m an agem en t (i.e.

in t r odu ced by a lar ge t r u st com pan y on ly t o f in d

pr oxy vot in g f or cer t ain cau ses, pu t t in g f or t h in vest or

ou t t h at Exxon M obil w as t h e f ou r t h lar gest

r esolu t ion s on m at t er s, et c.). Fait h -Based in vest in g is

h oldin g! I do n ot k n ow m an y ESG in vest or s w h o

cer t ain ly som et h in g w e can do f or specif ic clien t s, bu t

w ou ld f in d t h at accept able.

w e don't bu ild ou r of f er in g ar ou n d it . So, w e set t led on

-

It 's t h e Wild West ou t t h er e - Wit h so m an y n ew

t h e acr on ym " ESG" . You sh ou ld k n ow t h at t h is asset

par t icipan t s in t h is space, I believe t h at you

class, f or w an t of a bet t er t er m , is a bit of a dan ger ou s

h ave t o possess som e exper ien ce t o be able t o

place t o t r ead alon e, w it h ou t t h e advice of a qu alif ied

sor t ou t t h e good in vest m en t s f r om t h e bad,

f idu ciar y f ir m like ou r s. Th er e ar e sever al r eason s t h at

t h e t r u st w or t h y ven dor f r om t h e ch ar lat an ,

w e f eel t h is w ay, bu t h er e ar e ju st a f ew :

an d r eliable r esear ch f r om t h at w h ich is u n t est ed an d n ot applicable.

Wh ile n ot a " h ow -t o" gu ide, It 's m y h ope t h at t h is

-

Bad Investment Vehicles- As t h is st yle of

r epor t w ill h elp you u n der st an d t h is st yle of in vest in g,

in vest in g h as gr ow n in popu lar it y, m an y

avoid m ist akes, an d aid you in t h e select ion of a

in vest m en t f ir m s h ave join ed t h e par t y, f r om

qu alif ied ESG in vest m en t m an ager or con su lt an t .

Artifex ESG presents | A Guide to Successful ESG Investing

I dent i f yi ngYour Pr ef er ences

Artifex ESG presents | A Guide to Successful ESG Investing

Pursuing an ESG Investment program makes no sense unless you first define what you want to emphasize and what you would like to exclude from your portfolio.

Additionally, you should think about areas for compromise, i.e. how much of a role an asset should play (if any) in your portfolio if it fails only a portion of your screen.

Th e f ir st st ep is clar if yin g w h at it is you w ou ld like t o

w ou ld like t o exclu de or em ph asize in you r por t f olio.

accom plish by cr eat in g an im pact por t f olio. A good

Wh et h er t h e im plem en t at ion in volves m u t u al f u n ds,

place t o st ar t is by u sin g ou r pr ef er en ces su r vey. Th is

in dividu al st ock s, in dividu al bon ds, or ETF's, t h is

t ool w ill h elp you iden t if y t h e t ypes of act ivit ies you

blu epr in t w ill gu ide you r u lt im at e select ion s.

On ce you r pr ef er en ces ar e con f ir m ed, t h e n ext st ep is t o scr een f or possible in vest m en t s (w e u se t w o dist in ct t ools at t h is poin t - depen din g on t h e asset - in dividu al st ock or m u t u al f u n d). Th is is w h er e t h in gs get in t er est in g as good scr een in g t ools ar e r ar e an d t en d t o be expen sive, even f or m u t u al f u n ds. So it w ill pay you t o h ir e a f ee-on ly advisor w h o specializes in t h is st yle of in vest in g t o h elp you , even if it 's sim ply f or a sh or t -t er m con su lt in g pr oject .

Af t er t h e in it ial scr een in g, t h e r esu lt in g can didat es sh ou ld t h en be scr een ed based on in vest m en t f u n dam en t als, su ch as valu at ion m et r ics, f in an cial ch ar act er ist ics an d f u t u r e pr ospect s. An eye t ow ar d m ain t ain in g adequ at e por t f olio diver sif icat ion is also im per at ive at t h is poin t . At Ar t if ex, w e u se f ou r addit ion al an alyt ical t ools t o assist u s w it h t h is ph ase .

Fin ally, t h e r esu lt in g por t f olio sh ou ld be r eview ed in t ot al, an d, if accept able, im plem en t ed an d m on it or ed on an on goin g basis.

Artifex ESG presents | A Guide to Successful ESG Investing

I nvest ment Anal ysi s

Artifex ESG presents | A Guide to Successful ESG Investing

ESG portfolio analysis is multi-layered

In addition to the standard procedures for investment analysis, such as reviewing financial statements, press releases, corporate news, analyst calls, etc. an ESG portfolio requires additional layers to the analytic framework. As previously mentioned, your personal values are step one.

Step two involves screening for securities or funds that meet your criteria, and the third step is the fundamental analysis on the investment to determine whether it meets our standards.

passes as an ESG investment for one manager may not even come close for another - and they can each substantiate their choice.

The bottom line is that if you have a significant portfolio, you may want to build it piece-by-piece with the help of an experienced advisor. Or subscribe to some of the better research tools and do-it-yourself, if you are so inclined.

Given the changing landscape and the growing participation by asset managers, mutual funds and brokerage firms, you cannot assume that investing in a mutual fund that says it is SRI, ESG, Impact or RI (Responsible Investment) will actually represent your interests. As a matter of fact, I recently evaluated 5 of the top exhange-traded funds by asset size, and discovered that anywhere from 18% to 30% of their holdings would not pass our ESG screens. In a fund with 100 stocks, that means that 18-30 of them would not be suitable for the vast majority of our ESG clients.

In my opinion, there are two reasons for this: 1. There's a mad rush for investment firms to enter this space and get their share of client dollars. So some of these companies are slapping labels on their funds just to attract your money and your attention.

2. Responsible investment research tools and standards are all over the map. Some are very good, and some are terrible. Not only that, but there's a dearth of experience in this sector of the profession. So what

Sample ESG report on a major exchange-traded ESG fund showing a 30% failure rate. (Ideal Ratings)

Artifex ESG presents | A Guide to Successful ESG Investing

Sample ESG Asset Reports

Here are two of our most commonly-used report formats for ESG portfolio holdings. The report on the right is a summary of detailed ESG criteria available on one (Analog Devices) of over 11,000 domestic and international companies. We can screen using your preferences and then review each potential holding in detail. Conversely, we can take an existing portfolio and evaluate it's quality from an ESG perspective. If you are viewing this brochure online, you can click on each report and page through it to become familiar with the format.

LThe report on the left is an example of a mutual fund review. In this case, we are looking at an ESG fund, the Parnassus Endeavor Fund. Using analysis such as this enables us to determine how a fund rates on a variety of criteria, and whether or not it belongs in your portfolio.

If the prospective holding passes your initial screen, the next step is to evaluate each according to fundamental and fiduciary analysis, for which we employ multiple proprietary and third-party resources. During this phase of the review, we consider the tenure of the fund manager, the expense ratio of the fund, performance, risk, and multiple other factors.

Constructing a portfolio of individual equities involves intense fundamental analysis after the initial ESG screen, focusing on various valuation and financial metrics of a company before presenting it for inclusion.

Artifex ESG presents | A Guide to Successful ESG Investing

Sample Fundamental Investment Analysis

Once we've identified suitable holdings for a client's portfolio from an ESG perspective, we move on to the fundamental analysis. For this we use multiple sources, but provide you with samples of two such reports here. The report on the left is a Fiduciary Analytics report on the Parnassus Endeavor mutual fund. In addition to standardized performance and expense data, this tool give us detailed information on 11 key metrics that evaluate the fund's adherence to sound fiduciary principles. If we don't get a good score here, we often do not proceed. Again, you should be able to click on each report for a better view.

Including individual securities in a portfolio requires additional diligence, and we often start with detailed financial summaries provided by GuruFocus, which is an outstanding resource for equity evaluation. We consider such things as the company's value on a Discounted Cash Flow (DCF) basis, Return on Equity, Return on Invested Capital, trends, forecasts, balance sheet, income statement and statements of cash flow, among others. We will then check our analysis versus other analytical research that we subscribe to.

If you ar e u n able t o view t h ese r epor t s, sen d m e an em ail at dou g.k in sey@ar t if exf in an cial.com an d I'll sen d t h em t o you .

Artifex ESG presents | A Guide to Successful ESG Investing

ESG investing can not only result in a portfolio aligned with your values, but also in more consistent and improved performance As ESG investing matures, it has become possible to obtain returns that are equivalent, if not better than comparable indexes. This is a result of better information, more participants in this niche, and more robust research and analytics. When you consider that some of the key variables

that indicate a strong investment from an ESG perspective can also be evidence of a quality company, the result can be better overall performance. Consider variables such as concern for the environment, ethical treatment of employees, and other indicators of concern for others and our planet.

Who wouldn't want to invest in companies like that?

As an example, we created a plain-vanilla SRI portfolio in 2014 by filtering companies in our large company core model and adding a few where we needed diversification. We continue to manage this portfolio and track it versus relevant benchmarks. You can see from the chart at left that the model (the blue line) has performed very favorably vs the S&P 500 (yellow) and an ESG Index (red) during this timeframe.

Additionally, the chart at right illustrates favorable risk-return characteristics of the model. While the standard deviation is higher by 1-1.5%, the return is also higher at 10.15% versus 8.57% for the ESG benchmark and 9% for the S&P 500.

The point is not that the model delivers lights-out returns, but that a strategy such as this can deliver competitive results.

Artifex ESG presents | A Guide to Successful ESG Investing

Conclusion

Artifex ESG presents | A Guide to Successful ESG Investing

In conclusion, we applaud your interest in this investment discipline, and encourage you to pursue it as a viable strategy and as a way to express your values to the world.

We believe that the most successful investors work as much from their heart as their head. How else can you describe the amazing success of the few great investors like Warren Buffett and Peter Lynch? As much as the public tries to understand the financial process that great investors follow, we sometimes overlook the synergy between their financial wisdom and what their heart (or gut) tells them. Warren Buffett historically has not purchased companies he didn't believe in, or that didn't have quality products or that have poor management. Same for Peter Lynch when he ran the Magellan Fund for Fidelity Investments. He preached buying companies you know and do business with. Would you do business with a company you didn't like? If not, why own a company you don't admire in your portfolio? And in the end, you just may end up influencing the world we live in for future generations.

If you want to learn more about this topic, and how we can help you to express your values, visit us at artifexfinancial.com/ artifex-esg

Artifex ESG presents | A Guide to Successful ESG Investing

ESG Resources

Ensogo Analytics - www.ensogoanalytics.com ESG Research for mutual funds and ETF's.

Ideal Ratings - www.idealratings.com ESG, Shariah, SRI screening and analytics for domestic and international equities.

USSIF - The Forum for Sustainable and Responsible Investment - www.ussif.org. Resources and information for Responsible Investing.

Ceres - www.ceres.org - ESG research on publicly-traded companies.

CookESG Research - www.cookesg.com - information on carbon and climate risk.

Guru Focus - www.gurufocus.com - non-ESG equity research and screening tools.

A few of the more-established mutual fund families specializing in ESG investing (not a recommendation, but good educational sources) PAX World Funds - www.paxworld.com Parnassus Funds - www.parnassus.com Calvert Funds - www.calvert.com

And of course, call us at 855.752.6644 or visit our website at www.artifexfinancial.com/artifex-esg.