Make money by making the world a better place.
What’s not to like about that? So appealing is the idea of doing well by doing good that a significant slice of the financial services industry is devoted to persuading people that they can invest with their values without sacrificing returns. That’s what so-called socially responsible mutual funds are all about.
R. Paul Herman, the founder and CEO of an investment advisory firm called HIP Investor, goes a step further: He argues that companies that are leaders in sustainability and corporate responsibility are likely to outperform their peers. Those companies can be identified by using publicly-available data, he says. So by constructing an index of big companies, and investing more money into the better companies and less into the not-so-good, Herman says he both promote good corporate behavior and make money for his investors.
HIP stands for Human Impact plus Profit, Herman explained today during a talk at the Kenan Flagler business school at the University of North Carolina. (I’m in Chapel Hill for a couple of days, participating in a conference called Global Innovations in Energy organized by Kenan Flagler’s Center for Sustainable Enterprise.) I interviewed Herman, who gave a talk about HIP investing and his brand-new book, called The HIP Investor: Make Bigger Profits by Building a Better World. He’s a personable, 41-year-old Wharton grad who did a stint at McKinsey and worked at Ashoka.org and the Omidyar Network before starting HIP.
The core of his argument, as expressed on the HIP website, goes like this:
Our world of more than six billion people faces many human problems that need solutions, many of which can be served by companies. By solving these human needs profitably through products and services (from Walmart’s $4 generic drug program to ICICI Bank’s micro-loans to Vestas’s wind turbines), a company can benefit customers, inspire employees, engage suppliers, and deliver sustainable profitable growth for its investors.
Well, sure. Like many, I believe that Herman’s fundamental investing thesis makes sense. I wrote it right into my bio: “Companies that make the world a better place—by serving their customers, their workers and their communities—will deliver superior results to their owners in the long run.”
The challenge for an investor comes in identifying those better companies and deciding whether they are fairly priced by the market. Efficient market theory would argue that any information about companies gathered by Herman has already been factored into their stock price, since he works from public information.
Just to be clear about how his model operates: Herman’s HIP 100 Portfolio includes the same 100 companies as the S&P100, the big, familiar names like ExxonMobil, Wal-Mart, Citi, Goldman Sachs, Dell, Disney, Chevron and P&G. But unlike the S&P index, which weights the companies by their market capitalization–bigger companies get a bigger share of every dollar invested–the HIP 100 Portfolio weights them based on an analysis of their products, their management practices, their reputation with customers, their environmental impact and their ability to satisfy five human needs (Health, Wealth, Earth, Equality, Trust).
What does this mean in practice? When compared to the S&P100, Herman told me: “We have more Intel, more Cisco, more United Technologies, more P&G. We have dramatically less Exxon, significantly less Wal-Mart.” Google? Less than the market index. Ford Motor? More.
The Portfolio’s Top 10 holdings are Procter & Gamble, GE, Intel, UPS, H.J. Heinz, HP, PepsiCo, Cisco, IBM and Nike, according to an overview that you can download here.
As usual, things get squishy when you dig into the details of any investing model. Why PepsiCo rather than Coke? Why HP instead of Dell? Why UPS rather than FedEx? More to the point, are you persuaded that PepsiCo, HP and UPS will outperform their rivals because of their superior environmental and social practices?
What’s more, the criteria that determine the HIP 100 inevitably include value judgments, as does any approach to investing. Herman basically likes nuclear power, he told me. He doesn’t like Washington lobbying–companies that spend more money than their peers trying to influence legislation take a hit. That’s strange, since it would penalize GE or Duke Energy or Nike for spending on behalf of environmental legislation like the Waxman-Markey climate bill. Transparency matters a lot, so Google, which does lots of good things but keeps lots of information about itself private, suffers as a result. Note the absence of oil or coal companies from the Top 10, which makes sense from a “green” standpoint but suggests that performance will suffer if energy prices rise.
Herman points to the performance of the HIP 100 Portfolio as evidence that his model works, saying:
The HIP 100 portfolio has consistently outperformed the S&P 100 Index by at least 400 basis points (4%) annually over the past five years, when backtested in a model.
But back-testing is a crude measure. More significant is the actual performance since HIP Investor launched the HIP 100 Portfolio last July 30.. Those results are not quite as persuasive. Between July 30 and December 31, 2009, the value of the HIP 100 grew by 14.23% while the S&P100 grew by 12.23%, net of fees. That’s a 2% edge which takes into account the fact that HIP Investors charges a 1% management fee and works through a broker-dealer, FolioFN, that charges another 0.25% fee. Six months, of course, is not nearly long enough to test out the validity of any model.
Now, don’t get me wrong. I fervently hope that the HIP 100 Portfolio thrives, just as I would like to see the Dow Jones Sustainability Index, the FTSE4 Good Index and social fund families like Domini, Calvert and Portfolio 21 do well. (Especially the latter three, since I’m invested in all three.) I’m sure those indexes and funds do some good just by keeping a close eye on corporate practices. They’re useful watchdogs and, in the case of the social funds, effective shareholder advocates for causes they believe in.
But I’m not persuaded that there’s any single model that can consistently outperform the market. The social funds, as a group, have failed to do so. So, as best as I can tell, have the sustainability indices. (I couldn’t find historical performance data on the DJSI website.) In fact, it’s sad but true that the vast majority of actively managed mutual funds underperform index funds over time because of their higher fees and trading costs.
Put simply, most fund managers aren’t worth whatever they are paid.
Will Paul Herman be the exception? I hope so. But I’m not betting on it yet.