This week, I learned about an innovative approach to investing. A new firm called Life + Liberty Indexes has created what it calls the Freedom 100 Index of emerging markets stocks. Unlike other indexes, which typically weight stocks in proportion to their size, the Freedom 100 weights countries by measures of freedom. These include freedom of religion, freedom of the press and freedom of assembly, among others. In short, the Freedom 100 looks like it could have been created by the authors of our Declaration of Independence.
As a result, the Freedom 100 looks very different from other indexes of emerging markets stocks. For example, the FTSE Emerging Markets Index, on which Vanguard bases its emerging markets fund, allocates more than a third of its assets—the largest weighting by far—to China. It also includes allocations to Russia, Saudi Arabia and other places where “life, liberty and the pursuit of happiness” aren’t necessarily the government’s motto. Meanwhile, the Freedom 100 excludes all of those countries entirely.
Life + Liberty Indexes just launched, but it raises a broader question: Should you align your investments with your values? Especially with the growth of index funds—which seek to own all of the stocks in a particular market—this is a question worth considering. While I am a big believer in index funds, I recognize that they carry an unavoidable wrinkle: When you own an index fund, you unwittingly become a shareholder in many companies you might not otherwise want to own. The S&P 500 Index, for example, includes companies that make cigarettes, alcohol and weapons.
The good news is that there are a growing number of ways to solve this problem. In addition to the Freedom 100, lots of other “socially responsible” indexes exist, and lots of funds have been built around these indexes. Blackrock, for example, offers nine such funds, covering domestic and international stock and bond markets. Vanguard Group offers several as well. If you wanted to build your entire portfolio around these funds, you could.
But before you do that, these are some questions to consider:
How do you define “socially responsible”? Some years back, I worked for a firm that had a policy against buying stocks in alcohol, tobacco and gambling-related companies. It was, I thought, a good policy and successfully screened out most so-called “sin” stocks. But there is no universal definition for “socially responsible.” You could just as easily make a policy to exclude companies that make assault rifles, pesticides or opioids. Or you could judge companies based on their environmental track record, or their approach to charitable giving or respect workers’ rights. Everyone has their own criteria. (In my own case, it drives me crazy that, via index funds, I am a shareholder in a company called Navient, which is a big player in student loans, with a reputation for being not such a friendly player.) And to complicate matters further, many companies score well on some criteria but poorly on others. So if you want to tilt your portfolio to align with your values, the first question is how you want to translate your values into an investment policy.
Is investment performance a concern? For years, many have wondered whether it would help or hurt performance to invest with a socially responsible filter. It hasn’t been an easy question to answer. For starters, as noted above, there is no single definition of socially responsible. And many of these strategies are new, so there isn’t enough data to make reliable judgments. That said, the data does seems to indicate that, on balance, you won’t sacrifice investment performance—and you might even benefit—if you went the route of a socially responsible portfolio. But there are no guarantees. This is still a developing area, and depending upon the approach you take, the only thing that’s guaranteed is that your results will vary from the overall market. For that reason, if you do want to go the route of socially responsible investing, you might try it with only a portion of your investments.
If you want to better align your portfolio with your values, how should you proceed? I see at least three options:
1. Funds: Today there are more than 350 funds that fit in the category of “socially responsible.” That’s both a blessing and curse. Because everyone defines that term differently, it will require a good amount of research to find one that matches your own personal philosophy. But there is probably one out there that will be a reasonably good fit.
2. Custom portfolio: If there isn’t a fund that meets your needs, another approach would be to build your own portfolio from scratch. This would allow you to effectively build your own personal index fund tailored to your values. My only caution: If you go this route, be careful of costs. Because of trading commissions, this would make sense only for a larger portfolio.
3. Offset your sin stock profits with charitable giving: If you’re not interested in building your own fund or choosing one off the shelf, there’s another approach you could consider: You could stick with standard index funds but then make it an intentional part of your process to contribute to charities that reflect your values. In a sense, take profits from companies you consider socially irresponsible and use those dollars to support causes that are socially responsible.