What images come to mind when you think of investing for good? Tree huggers willing to sacrifice financial returns for purpose, perhaps?
It’s time to bust that myth wide open.
As it turns out, investing for good can be more profitable than traditional investing. What does that mean for you? Even if your heart isn’t into saving the planet, it still makes financial sense to have a look at socially responsible investing.
Green Alpha Advisors is a Colorado asset management company taking a bold approach to sustainable investing. Garvin Jabusch (CIO), Betsy Moszeter (COO) and Jeremy Deems (CEO) sat with us for an in-depth interview to share with our readers why sustainable investing makes sense, even if you’re only looking for better returns.
Because it’s about investing in What’s Next…
Green Alpha believes that sustainable investing makes more sense than traditional investing. Why? “Because it’s about what’s next,” says Deems.
Green Alpha’s philosophy is simple: the companies solving the world’s biggest problems are the ones that will drive economic growth. Put another way, there is no commerce without an ecosystem. Those companies tackling the largest global systemic risks such as resource scarcity, climate change and widening inequality are the companies that will thrive in the future.
Q&A with the Green Alpha team
1) Why not just invest in an S&P 500 fund and forget about it?
Garvin Jabusch: The reason why people are in those broad market index funds is that they’ve been told that’s the best way to invest, and also, they’re just ubiquitous, and they have performed well. And they are extremely cheap. On that level, broad market index funds make sense. If you can pay 10 basis points (0.1%) for a fund, I can get why that looks attractive and why I’d want that.
But what if you want to invest in the Next Economy and de-risk your portfolio from resource degradation and climate disruption, how do you make portfolio choices? Well, not by selecting from an index list, but by starting from scratch and building a new model of an economy that works from the floor up…but these portfolios need to, over time, perform the equivalent or better than the index. And that’s the point. The S&P 500 and other legacy economy benchmarks are not the future and therefore not as interesting in terms of returns generation going forward.
2) Why aren’t the S&P 500 and other legacy economy benchmarks the future?
Garvin Jabusch: Because indexing is purely indiscriminate. If you buy an index, it does not matter what a constituent company does. You don’t care in the least what the company does to make money or how they will continue to make money and grow going forward. You just buy it because it’s in the index.
Think about the S&P 500. It contains 60 fossil fuel stocks. If you believe, as we do, that fossil fuels are going to be less and less important as a source of energy for the global economy, then why would you invest in these companies? This is where tree huggery has nothing to do with it. – Garvin Jabusch
From last year, 2017, when electric vehicles started emerging and growing in a meaningful way, and as renewables continue to take over the power grid, it’s hard to see a source for growth for fossil fuels in the long term. And therefore why would you want to own those?
Well, you own those because you’ve indiscriminately purchased the S&P 500 for years. If you watch any of these finance channels, this is what we’re told: just buy the cheapest index you can. So this is the paradigm we’ve inherited. Modern portfolio theory and the efficient market theory says you can’t do any better than the index so just find the cheapest index and own it.
But all that disregards the fact that the index is full of the legacy economy and the sources of large-scale systemic risks, that, by definition make poor long-term investments.
3) What’s the Blindfold Test?
Jeremy Deems: Every time investors buy an index, they bid up the prices of those companies in the index. Exxon is trading around 23x earnings yet has had shrinking revenue 5 of the last 6 years. That’s expensive. That’s way too high of a multiple for a shrinking company.
People are throwing gobs of money into the S&P 500. That means 1.5% of every dollar towards the Exxon share price even though it’s a shrinking company. – Jeremy Deems
But a funny thing happens when you blindfold the names of companies in the S&P 500 and start looking at fundamentals. On the one hand, here’s Exxon, one of the largest companies in the world. It has shrinking revenues and prospects from an industry standpoint, and it’s trading at a 23x multiple. Is that a buy? The answer from most equity analysts would be “NO.”
Then you hide the name of a Solar company that trades at or below book value and has been experiencing 30% growth, the same analyst would say that’s an undervalued stock. Fundamentals matter, both at a macro level as well as a stock-specific level.
4) Won’t Next Economy companies come into the S&P 500 eventually anyway?
Garvin Jabusch: Yes. Index turnover is a thing. These new economy companies will come into the S&P 500 eventually. But if you have a long term investment horizon, wouldn’t you want to own these companies before they get added to the S&P 500, so you get to enjoy the majority of the gains?
The S&P 500 has the 500 largest companies in the U.S. A material portion of their growth phase is behind them by the time they get added to the index. Then, once they are in the index, if they start decreasing in size, they have to shrink quite a bit before they get kicked out.
Betsy Moszeter: Most investors don’t understand that by buying solely the biggest companies, you’ve missed on the growth that got them there. And you lose money on all the shrinkage as index turnover is very slow. Activity in the stock market, in general, tends to lag what’s happening in the economy by a few years. Investing specifically in indexes managed like the S&P 500 lags that even further.
Garvin Jabusch: As an investor, you’re interested in investing in economic changes, which are happening more rapidly than at any other time in history. The rate of change is increasing, as well as the change itself. For long-term equity growth, it is critical to be on the right side of change.
5) How do you know which Next Economy companies will make it into the S&P 500?
Garvin Jabusch: We don’t know. But we do know what industries and sectors are likely to be represented, so it’s a question of selecting leaders among those that we can get for decent valuations. And we also know that there are 60 or more companies in the S&P 500 that will be shrinking going forward.
6) How about risk? How does your portfolio risk compare with S&P 500?
Garvin Jabusch: This is one of my favorite questions. What we do differently is all about a redefinition of risk. It’s about ignoring the legacy concept of modern portfolio theory which defines risk very strictly as correlation with the benchmark. Today, almost everyone in asset management very much believes in modern portfolio theory.
But here’s the thing. When the economy was evolving less rapidly, you could say that the economy in the 1950s still looked like the economy in the 1940s. And the economy in the 1960s still looked a lot like the 1950s. Change was happening, but it was slow.
The 1950s is when modern portfolio theory was popularized by a guy named Markowitz and his famous book. And at that time, it did work. You could count on looking back 10 years and seeing what asset mixes looked good and had relatively good risk adjusted returns.
The old way is broken…
Markowitz’s efficient frontier thesis was brilliant, but it has come to be interpreted as “just index, because you’ll never do better.” So you have the nearly universal belief that indexing is the best way to invest in public markets. So much so that even managers trying to reflect a sustainable economy end up merely trying to hammer an index into something “green.” So in order to arrive at something they can label a “sustainable portfolio,” and also stay correlated with the big benchmark, what they do is peer rank, using a questionnaire, the sustainability of companies in every industry.
This fails of course, because in reality, it’s absolute not relative sustainability that matters. Relative rankings are meaningless. It is absolute performance that leads to transformation and drives valuations. If you own big indexes with all of their fossil fuels, you may think you’re investing passively, but in fact you’re not. You are actively betting on systemic level collapse. I wonder if Markowitz would even agree with the present application of his theory.
You can’t just look backwards anymore…
The economy 10 years from now won’t look an awful lot like the economy today. We’ve already seen that happen in the last 10 years. So modern portfolio theory fails and yet we all live by it because it’s the paradigm we’ve all accepted. It’s all we’re taught in business school and it’s all we see on CNBC, and that’s why we remain in broad market indices.
Modern portfolio theory is your daddy’s and your granddaddy’s investing and it’s busted now and it’s time for everyone in GenX all the way to GenZ to throw out the inherited paradigm and start afresh. – Garvin Jabusch
7) Then what does redefinition of risk mean?
Garvin Jabusch: There’s this perception that the S&P 500 is the place to go for low risk equity exposure. Yet, if you think about what you are exposed to, you have tons of present and future systemic risk.
A redefinition of risk means no longer defining risk as correlation with the S&P 500. The S&P 500 itself is extremely risky. It is riddled with systemic risk to the global economy, starting with fossil fuels but also including things like glyphosate makers that are depleting farmland with deleterious water practices, and with all kinds of short term resource exploitation as opposed to long term resource management.
It’s time for the definition of risk in investing to correlate with actual risk to the economy, and not with mathematical beta risk to some benchmark. – Garvin Jabusch
So if the index itself is quite risky in fundamental real terms, not in math correlation terms, but in fundamental real terms, then defining correlation with it as ‘low risk’ is nonsensical on its face.
This is what we need to subvert and get the whole world to recognize. Risk isn’t volatility versus a benchmark. It’s what actually has the power to undermine the global economy.
8) How do politics come into play?
Jeremy Deems: On the one hand, it doesn’t matter which party or individual in control of an administration or congress. It’s about the economics. If a technology makes more economic sense at scale, then eventually, despite best efforts to block progress, better economics wins out. Look at Iowa and many of the Mid-Western states and their mass adoption of wind power due to the clear economic advantage to produce cheap power. Just try to take their wind power away and see what happens.
Above all, it’s about the economics…
We do manage political risk over the medium to long term. How do certain changes affect an industry and its long term innovation curve? This is not a one or two-term thing. Simply put, our approach is this: In order to have a vibrant economy, we must have a planetary ecosystem that is capable of supporting it. We can’t have any kind of commerce without an ecosystem. We invest in the Next Economy, one in which our footprint is dramatically reduced, therefore allowing our planet to support our economic systems.
It turns out that a petrochemical-based ecosystem is too hard on the planet to support economic growth when you think about the number of people we have to feed and the fact that everyone seeks better standards of living. You can’t do that with an energy source that you dig up at great expense, burn it once, and don’t get to use again. That is a resource constraint. This is not a left or right issue. That is economics not working. That’s the crux of a Next Economy thesis. It’s got to be a circular economy. Waste has to have value until you literally can’t make anything else out of it.
We now have better alternatives to powering our economy from both an economic and environmental point of view. It’s critical to move capital towards these solutions and furthermore, these innovations represent massive levels of wealth creation. – Jeremy Deems
9) Has the U.S. lost global clout?
Jeremy Deems: Yes, there are significant U.S. political headwinds. There’s an entrenched interest in Washington to not disrupt the fossil fuel economy. This makes sense. People circle the wagons around what’s worked in the past.
Yet, here we are, with a clean tech revolution. We have the opportunity to take the lead, not only with IP (intellectual property), but also with technology production. Yet we’ve chosen not to. Or we’ll slap tariffs on things and say we can’t compete. Well, the reason we can’t compete is because we chose not to.
How un-American is it to say that we can’t compete with China who did subsidize solar (why is that a bad thing)? That’s why their process is now less expensive. We, on the other hand, choose to subsidize fossil fuels. We made our bed, and now we’re whining about it. -Jeremy Deems
Meanwhile, some folks who aren’t in the fossil fuel business are investing in some of the most efficient solar panels and wind turbines in the world. We should have been investing in this as a nation all along and competing harder. President Xi has gleefully stepped in as the world leader in renewable energy. He has clearly taken leadership right away from the United States. From China’s point of view, it is gaining credibility, cheap and clean power, and market share, all while attracting new talent. China is now encouraging technological innovation the way the United States had done for most of the 20th century.
The silver lining…
Jeremy Deems: But there’s a silver lining. There’s been an interesting development. And now we have the data to point to it, which we didn’t have a year ago.
- People in general have decided that their capital might be more important than their vote. We are seeing a digging in by the most progressive companies in this country to fight for What’s Next. Some of the largest companies in the world are now striving towards. or have already achieved. 100% renewable energy sourcing. This is a tough country to do that in right now, yet it proves that the economics are better.
- The cost curve on solar, wind, and storage units has plummeted, despite headwinds to keep it from doing just that.
We’ve definitely seen empirical evidence that what’s happening in Washington is also having a positive impact in the US private sector, but also globally. Some firms are saying: we’ll do business elsewhere. Others are doubling down on doing things on their own.
In the future, when we look back at this, even the tariffs, we will see that this was fuel on the fire for change more than perhaps it would have been otherwise. – Jeremy Deems
People have been galvanized into the B Corp spirit – to use business as a force for good. But also, in terms of a cultural and competitive performance point of view, companies and investors want to take a leadership role in investing in What’s Next, in investing for good.
10) How have your portfolios performed over time?
Betsy Moszeter: Our portfolio returns are completely solid. Without a ton of disclosures added, I can’t comment on them specifically in a written interview, so I encourage you to look up the actual results posted on our website.
The Next Economy Index
Our oldest product is 9 years old. We call it the Next Economy Index. The Index contains all of those companies we love that are creating solutions to one more of our greatest systemic risks,. They’re well-run companies with strong management teams, that are trading at a good price relative to their peers for their proven and expected good growth rates. The Index itself is a great portfolio; further, the stocks that make it into the Index are then eligible for the rest of our portfolios, which each have unique portfolio construction goals.
Sierra Club Green Alpha portfolio
We also have a Sierra Club-branded portfolio that is 7 years old. We are the only financial services company allowed to use the Sierra Club proprietary social and environmental screening criteria to build investment portfolios. This is a mash-up of Green Alpha’s forward-looking investment approach, and screens it against the Sierra Club’s rigorous criteria, including evaluation of a company’s operating history.
Growth & Income
Our Growth & Income portfolio is more than 5 years old and it looks at those companies in the Index that tend to be larger cap, stable companies paying higher-than-market dividend yields. This appeals to a wide variety of clients looking to benefit from both the growth of sustainability-oriented companies, and the relatively high dividends that these companies pay out. Most of our clients who select this portfolio reinvest the dividends to benefit from the compounding effect on their wealth creation.
Shelton Green Alpha Fund
Finally, our the mutual fund that we sub-advise is called the Shelton Green Alpha Fund (ticker: NEXTX) and it is 5 years old. Managing increasingly larger accounts as we grow, our company moves more money in the economy and, therefore, has greater impact. We also strongly believe that every investor should have access to high-quality investment portfolios. While we offer relatively low minimum account sizes on the portfolios I described previously, the mutual fund has our lowest minimums and is our best “democratizer.” People can start investing with as little as $500 and have a well diversified equity portfolio. It’s also a great option for employers to include in a 401(k) plan, as employees are increasingly demanding access to quality ESG investing vehicles or else they won’t participate in the company’s plan.