Advocacy Investing Catnip for Wealthy Clients?

Marc Lane was skeptical about social investing, until he did his homework and found a more profitable approach

Whether your personal values make you a tree hugger or your core beliefs compel you to shun companies that provide benefits to same-sex couples — or even if you have no social agenda at all — you may want to consider a new approach to socially responsible investing. It's called advocacy investing and it is laid out in a slender tome called Profitable Socially Responsible Investing? (Institutional Investor Books, 2005). You could call it “the gospel, according to Marc.” Marc Lane, that is.

Advocacy investing has several important advantages over some conventional social-investing techniques — not least of them is helping clients actually make money. But for financial advisors, advocacy investing has an even more significant benefit: It is, potentially, catnip for high-net-worth clients.

How so? Wealthy people have several traits that predispose them to social investing, says Lane, who has ministered to wealthy clients as an estate and tax attorney and financial advisor for more than 30 years. First, many are activists. They tend to get involved in charities, foundations and social or political causes. Many of them are self-made entrepreneurs who built something from scratch. And the idea of using their financial muscle to further a social or environmental or moral agenda appeals to their egos; they like to think that they can change the world. Says Lane, “We are talking about people who are successful, people who are, candidly, privileged, who believe that with their money, with their status they should be in a position to promote positive social change.”

Social investing has always attracted some wealthy individuals and institutions, but industry veterans say that more high-net-worth clients are gravitating to SRI lately. “The thing I keep hearing about is the growth of interest from family offices,” says Cliff Feigenbaum, publisher of The Green Money Journal. “The transfer of wealth from one generation to another has fueled the fire. The inheritors say, ‘Grandpa had ExxonMobil, but we don't want that.’”

In particular, Lane says, well-heeled baby boomers are ripe for advocacy investing. “They started out by being opposed to the Vietnam War. They were supportive of the women's movement, the civil rights movement the green movement. So these are people whose lives have been influenced and shaped by their values. Now they are in a position to promote positive social change in all kinds of ways, through their philanthropy but also through their investments. They are predisposed, too, to seek to transmit their values to their children along with their money.”

Inherited Values

Lane should know. He has been working with wealthy individuals and institutions since establishing his law firm in Chicago in 1971. Initially, he advised clients on tax- and estate-planning issues, but quickly saw an opportunity to sell investment services, too. In 1985, he established his own NASD-licensed broker/dealer, Marc J. Lane & Co. In the 1990s, he began to have a different sort of conversation with his clients. New legislation in many states had opened the door to the creation of so-called dynasty trusts, which can exist in perpetuity. That got them thinking about how they might influence descendants three or four generations in the future, and they started to talk to Lane about using their investment choices to communicate their values, along with their money, to heirs.

“At that time I was very skeptical,” says Lane. “I said, ‘Look, I don't know much about this but the conventional wisdom is that when you invest in an SRI fashion you are looking at some performance give-up.’ But I also thought maybe there might be a way around that.”

With funding from one of his wealthy clients, Lane embarked on an eight-year research project, which resulted in the book. What Lane learned was that the most common approach to social investing — using negative screens to eliminate cigarette makers or gambling companies from portfolios, as most SRI mutual funds do — exacts a performance penalty. “We determined that yes, when you start excluding sin stocks you will have a less diversified portfolio, and, therefore, greater volatility. And greater volatility, of course, is a proxy for greater risk. So on a risk-adjusted basis, you may very well have underperformance with negative screening.” What's more, negative screening may not advance the investor's agenda: “Phillip Morris is not going to get out of the tobacco business because some investors refuse to buy its stock,” Lane notes.

However, when the team started toying with model portfolios that were created using positive screens — actively picking stocks of companies that scored well on measures like environmental stewardship or corporate governance — they began to see returns that actually exceeded those of relevant benchmarks. They studied 2,884 stocks of the Russell 3000 Index over the period between January 1995 and December 2003. The conclusion was that the positively screened portfolios consistently outperformed the benchmark in both absolute and risk-adjusted returns. The results varied, but were consistent for portfolios selected on social justice, diversity, human rights and environmental criteria.

Despite slightly higher betas than the benchmark, these portfolios also exhibited higher performance for level of risk (as measured by the Sharpe Ratio). Lane cites studies that explain why this may be so. Corporate performance data has shown, for example, that companies with good human resources policies have higher productivity and profitability; corporations that attempt to reduce greenhouse gas emissions and adopt other environmentally-friendly policies also perform better than similar companies that don't because they save on fuel costs and don't incur costly environmental liabilities.

In addition to the book, the study produced another new business: Marc J. Lane Investment Advisors, an RIA that sells custom portfolios based on the principles of advocacy investing.

Lane says that only personalized managed accounts can match results that he achieved in his model portfolios. SRI mutual fund managers can't match that performance, he says, because they must use broad criteria to attract a range of investors. Since Lane began his research, however, the number of SRI funds has more than doubled, providing far more choices and a wider range of styles and focus. And many SRI funds are competitive in their classes (see table). Still, SRI funds continue to have limitations, says Steve Scheuth, president of First Affirmative Financial Network, a fee-based investing firm that specializes in SRI. “It's a lot better than it was a few years ago, but it's still hard to get these clients into certain asset classes, including emerging markets, and there is very little in the way of funds that can provide exposure to real estate.”

Custom portfolios and managed accounts are absolutely the way to cater to the high-net-worth SRI investor, Scheuth says. Indeed, says Michael Lent, who, with his partner, runs the First Affirmative office in New York and has $375 million under management, “This is what we've been doing for 20 years.”

Like Lane, Lent starts with a questionnaire that captures data about the client's financial goals as well as their attitudes about various social and environmental issues. But where Lane creates a custom portfolio, Lent uses the custom-screening information to identify managers who can accommodate the client's wishes. “We might, for example, choose one who specialized in renewable energy,” he says. Lent also accommodated negative screening, which he feels does not necessarily exact a performance penalty. “It's a customer preference issue,” he says.

Love the Proxy

The final ingredient that makes advocacy investing so tasty for wealthy clients is the advocacy itself. “For many high-net-worth investors, that's the most important part,” says Scheuth. “They really want to know that their money is out there catalyzing change.”

Like other SRI managers and advisors, Lane has a team of analysts who monitor the performance of companies and get involved in proxy efforts. In the recent proxy season, they helped organize Lane's clients around issues like environmental reporting and board democracy — two hot buttons for shareholder activists.

For the financial advisor, the advocacy activity provides a great networking opportunity, Lane asserts. “From the rep's perspective, these voting blocs also create a network for referrals,” he says. Creating those blocs does require homework — the rep has to be up on the issues and committed to helping with the advocacy, including working with others in the SRI community to mobilize proxy efforts. But there is a payoff: “Once you have one of these clients,” says Feigenbaum, “the word spreads and you get their friends and associates.”

And the relationship with these clients is different. “You're taking the high road, which I think is a very effective approach to high-net-worth clients, because now you are no longer in a money-grubbing mode,” says Lane. You're talking to clients not just about their money, but about their values — the kind of world they want to pass on to their grandchildren. “You are having a very different kind of conversation and creating a different kind of relationship,” says Scheuth. “This is not how most advisors were trained. It's certainly not what I was taught 28 years ago at Shearson.”

From a marketing perspective that may be a good thing. “You have something that the rep in the next office doesn't,” says Lane. “And that distinction is accomplished by empowering the investor not only to maximize risk-adjusted total returns of the portfolio, but, in addition to that, drive his or her own personal values, convictions and principles. If you can do all that with no give-back, it's a no-brainer.”

Beating the Benchmark

How four portfolios, constructed with positive screening, performed*.

Portfolios Yearly Return (%)
Social justice 14.43
Diversity and employee relations 14.26
Human rights 14.61
Environment 14.61
Benchmark 13.63
*Portfolios cover January 1995 to December 2003, statistics are at a 50% level of rigorousness. The benchmark universe is the Russell 3000 Index.
Source: Marc J. Lane Investment Management

SRI's Top Performers

According to Morningstar, through April 2006 there were 111 distinct SRI funds with $43,479,314,882 in net assets, compared to 10 years ago when there were only 52 funds and a meager $7 billion in net assets. The growth is no accident: Some of the common knocks against the funds, not least of which is high expense and lagging performance, seem to have lost significant support (see chart below). “It's a niche that's growing faster than the industry as a whole,” says Greg Carlson, one of two fund analysts at Morningstar who cover SRI funds.

Listed below are the top 10 SRI funds by one-year return — excluding those funds that had fewer than $10 million in assets. Many have solid performance at the one-year, three-year and five-year marks, as well as expense ratios similar to or below 1.67 percent, the average gross expense ratio of all mutual funds at the end of February, according to Morningstar.

Fund name Ticker Category 1-Year Return % Rank Vs. Category 3-Year Return % Rank Vs. Category
Winslow Green Growth WGGFX Small Growth 48.18 1 29.34 4
DWS Global Thematic S SCOBX World Stock 43.85 2 27.37 14
New Alternatives NALFX Small Blend 33.94 9 22.17 47
GuideStone Funds Internatl Equity GS2 GIEYX Foreign Large Blend 32.99 39 26.35 18
Calvert World Values Intl Equity A CWVGX Foreign Large Blend 27.99 85 21.11 86
Amana Trust Growth AMAGX Large Growth 26.47 2 25.42 1
MMA Praxis International B MMPNX Foreign Large Blend 25.68 93 20.25 93
Citizens Emerging Growth Standard WAEGX Mid-Cap Growth 24.46 25 17.22 51
Timothy Plan Aggressive Growth A TAAGX Mid-Cap Growth 23.99 28 16.50 58
Amana Trust Income AMANX Large Value 22.74 4 22.08 2
* Excludes funds with less than $10 million in assets.
Source: Morningstar
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