Values-based investing — like socially responsible investing (SRI) and Environmental, Social, and Governance (ESG) investing — has gained significant traction in recent years, and with its increase in popularity, many nonprofits and associations are deciding whether to incorporate non-financial factors into their investment decisions. Many organizations want to align operations with their values, but how do they decide if they should align their investments with those values?
How Do We Get Started with Values-Based Investing?
A systematic approach can aid in the consensus-building process, and it’s important to be aware of certain trade-offs and potential implementation choices. We suggest 5 steps if you are contemplating values-based investing:
- Clearly define the organization’s values
- Gain consensus on whether those values should be factored into investment decisions
- Fully understand the tradeoffs involved
- Know the investment options available
- Document the process and update the Investment Policy
To successfully implement a values-based approach, there needs to be consensus around the organization’s values. However, achieving consensus within an organization can be a difficult process. Without well-defined values, it becomes challenging to make informed decisions about investments that align with these principles. In the absence of well-defined values, we would advise against values-based investing.
Clearly Define Your Nonprofit or Association’s Values
The first and most critical step in the journey towards values-based investing is clearly defining your organization’s values. These values serve as the guiding principles that shape the organization’s ethical and social framework. We recommend starting with an assessment to ensure values are clear and collectively understood. If clarification is needed, key stakeholders should be involved in a process to establish a shared understanding of the organization’s values.
Some organizations may find their values more easily align with available investment options than others. For example, it may be clear that an organization committed to sustainability would desire to use a sustainability focused investment. However, organizations with broader or more general values might face challenges in aligning their investments and values.
Gain Consensus on Whether Values Should Inform Investment Decisions
After values are defined, the next step is gaining consensus on if those values should factor into investment decisions. Not all organizations will find values-based investing a good fit. A high-level survey can provide a valuable opportunity for Board members to anonymously share their perceptions of the organization’s values and if they should be reflected in the organization’s investments. Ensuring everyone is on the same page will help the organization remain disciplined to the values-based approach.
Get comfortable with the performance and fee tradeoffs
The next step involves all key stakeholders gaining a comfort level with the trade-offs associated with values-based investing. This pivotal step will empower the organization to comprehend all involved costs and maintain discipline, especially when performance diverges from the benchmark.
One key consideration is tracking error, which measures how much an investment’s future return potential may differ from its benchmark. Values-based investing can involve promoting or restricting investment in certain companies or market sectors, resulting in short-term performance differences from the benchmark.
Organizations thinking about values-based investing must assess whether their Board or Finance Committee is comfortable with varying levels of tracking error. Investing effort in the initial alignment of values with investments can help increase tolerance for tracking error. While short-term deviations are expected, over the long term, performance should align more closely with the market.
Be prepared for periods of tracking error; for instance, a values-based US equity fund underperformed the total US stock market by over 3.5% in the first half of 2023. The fund’s underperformance was attributed to the exclusion of a few mega-cap technology companies due to labor or privacy concerns. Those companies contributed to the majority of the market gains during the period. Understanding and accepting tracking error is crucial for success, as abandoning the approach at an inopportune time could result in losses.
Fees are another consideration when adopting a values-based approach. Values-based investments consider both financial and non-financial criteria when making investment decisions. Managing a values-based fund requires extra effort and research, which adds to the cost. While fees have decreased in the last decade, values-based investments are still pricier than equivalent non-values-based options. Confirm the organization is willing to allocate additional resources for this endeavor.
Explore How to Implement Your Values-Based Investing Strategy
After clarifying corporate values and understanding the trade-offs, the next step is to identify how to implement the values-based approach. Organizations have two primary options for values-based investing.
One approach is to adopt investments that apply broadly defined ESG standards. These investments are typically cost-effective, easy to implement, and offer access to pre-established ESG investment choices. However, this option provides limited control over specific guidelines and exclusions, potentially compromising alignment with unique corporate values.
Another option is to create custom-designed values-based criteria, offering full control in shaping guidelines and restrictions to precisely align with organizational values. Custom design, though, may come at a higher cost and requires additional ongoing oversight and policy maintenance.
Document Your Values-Based Investing Process and Policy
Once the preferred approach is determined, it’s crucial to document the purpose, objectives, roles, risks, and performance expectations related to values-based investing. This ensures alignment with the organization’s values and financial goals and will enable future stakeholders to fully understand how and why decisions were made to implement a values-based approach. We recommend conducting interviews with key stakeholders and surveying the Board to understand and formalize corporate values. Then, draft policies outlining the goal, purpose, objectives, roles, risks, and performance expectations.
The rise of values-based investing has presented organizations with a critical decision: whether or not to integrate non-financial factors into their investment decisions. We’ve outlined a structured approach to guide organizations in this complex decision-making process. The first step emphasizes the importance of clearly defining organizational values. Understanding the trade-offs associated with values-based investing is the next crucial phase. This includes considerations such as tracking error and fees. Once these considerations are in place, organizations can choose between broadly defined ESG investments or custom-designed solutions to implement their values-based approach. Custom design offers greater control but may come with higher costs and additional ongoing oversight. Documenting the purpose, objectives, roles, risks, and performance expectations related to values-based investing is essential to ensure alignment with organizational values and financial goals. Values-based investing may not be the right fit for every non-profit organization. I hope this article provides a systematic approach your organization can use in determining its suitability.
Disclosures: TIAA-CREF Social Choice Equity fund – 12.53% v. the Russell 3000 index – 16.17% (YTD performance as of 6/30/2023)
Wondering how to take the first step to gain consensus on your values?
Our sample values-based investing survey is a great starting point for conversations that nonprofits & associations should have with your Investment/Finance Committee, Board of Directors, executive staff, and investment adviser.
Click below to download Raffa’s Sample Values-Based Investing Survey
Disclosures:
For informational purposes only. All figures in USD. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower.
All economic and performance information is historical and not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this material, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.
You should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Raffa Wealth Management or any other investment professional.
The charts and graphs contained herein should not serve as the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Raffa Wealth Management.
All information, including that used to compile charts, is obtained from sources believed to be reliable, but Raffa Wealth Management does not guarantee its reliability. All performance results have been compiled solely by Raffa Wealth Management, are unaudited, and have not been independently verified. Information pertaining to Raffa Wealth Management’s advisory operations, services, and fees is set forth in Raffa Wealth Management’s current disclosure statement, a copy of which is available from Raffa Wealth Management upon request.
[1] Annualized return in excess of market return for stocks after joining list of 10 largest US stocks, 1927-2022. After joining list of top 10 largest US stocks, those companies trailed the market by -0.9% and -1.5% annually over the next 5 and 10 years, respectively. Companies are sorted every January by beginning of month market capitalization to identify first time entrants into the 10 largest stocks. Market defined as Fama/French US Total Market Research Index. The Fama/French indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark.
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