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Build an SRI Portfolio without Sacrificing Broad Exposure – FinancialPlanning.com
By Kathy Kristof
June 09 2016, 2:42 PM EDT
When you set up a planning practice in Denver, a city of health enthusiasts and environmentally attuned residents, you have to expect that some clients will want to invest in ways that match their social aims.
But socially conscious investments — which might exclude alcohol, tobacco or defense stocks, among others — are in the eye of the beholder, says Matt Papazian, chief investment officer and co-founding partner of Cardan Capital Partners.
“Some of our clients are entrepreneurs in sustainable foods and sustainable products, and they want some investment dollars in that space,” Papazian says. “But you’ve got to span a whole gamut of issues, from a clean workplace to equality.”
Fortunately, as social investing has broadened its horizons, returns have also improved. Some 15 years ago, when Papazian first started building socially screened portfolios for clients at Merrill Lynch, conventional wisdom opined that these portfolios couldn’t match the performance of an index.
Now there’s a growing body of research that indicates socially screened portfolios can do every bit as well as non-screened investments.
Indeed, a 2015 study by Morgan Stanley found that mutual funds that screened for sustainability issues had equal or higher returns than those that didn’t. Better yet, they achieved their results with less volatility.
Of course, social investing has come a long way over the past dozen years. In the early days, there were fewer socially screened funds, and many of them charged high fees. That left Papazian designing his own social portfolios using individual stocks. But because every investor was sensitive to slightly different issues, clients were constantly trying to nix specific companies in the portfolio, which left them more vulnerable to industry and single-company risks.
“That’s how we knew how personal social investing was,” Papazian says. “It got incredibly complex and time-consuming.”
At Cardan Capital, Papazian now mixes 10 socially screened mutual funds and ETFs to make up a custom SRI portfolio for clients. This approach keeps fees low and gives the fund broader exposure with less individual-company risk.
Cardan’s socially screened portfolio includes industry stalwarts such as the iShares MSCI KLD 400 Social ETF and the iShares MSCI USA ESG Select ETF, which provide broad exposure to both U.S. and international companies with positive practices. These include NextEra Energy, a utility heavy on wind and solar power, and Google.
But Cardan’s custom SRI portfolio also includes younger and more-focused funds such as the Workplace Equality ETF and the Barclays Women in Leadership ETN, which address gay and lesbian issues and gender equality, respectively.
Notably, the aims of the Women in Leadership fund seem to mesh nicely with those at Cardan, which was formed by Papazian and several of his former Merrill colleagues. The Barclays fund, launched in 2014, invests in companies led by women CEOs or with boards consisting of at least one-quarter women, on the theory that “gender-diverse leadership may correlate with relatively stronger corporate performance,” according to its prospectus. At Cardan, women outnumber men five to three, and account for two of the four partners.
“Women have a different approach and a different way of looking at things that can be really valuable,” says Papazian. To achieve the benefit of gender diversity with every client, Papazian says the firm attempts to get both male and female perspectives on every plan.
Of course, with just a few months of independence under its belt, Cardan Capital is still working out some of the kinks. Papazian; Sarah Keys, a family law attorney; Ross Fox, the former manager of Merrill’s Denver office; and Martha Awad, a CFP, CFA and tax attorney, broke off from Merrill to form their own firm in November 2015.
Almost half of their clients jumped ship to join them in just the first two months. That triggered a “tsunami of paperwork,” says Keys, who estimates that they needed to fill out 21 pages of forms and transfer documents for each of the firm’s 200 clients.
By now, the vast majority of their old clients have switched over. Cardan has amassed $520 million in AUM, and has yet to pursue referrals.
“It’s been a bit like drinking from a fire hose,” says Keys. Referrals don’t appear to be a problem, she adds: “A lot of our clients are entrepreneurs, and we are getting more referrals from people who seem to like that we are now entrepreneurs ourselves.”
Key to Their Success
The key to their success is also one of the key reasons they left Merrill. Their roles at Merrill precluded them from describing themselves as fiduciaries, even though Papazian says they’ve always subscribed to that standard on behalf of their clients.
Team members had contemplated joining other wirehouses, knowing they would each get “big checks” had they gone that route. But as they watched the Department of Labor work out a final fiduciary rule, they felt independence was their best option.
So they researched the cost of hanging out their own shingle, drew up a business plan and started socking away money.
They budgeted for $750,000 in start-up costs and also built up their personal emergency savings to provide for the off chance that fewer clients would follow them, or that the transfer process would take longer than they anticipated.
“We have always acted as fiduciaries,” Papazian says. “In my mind, there is no reason for an advisor to act in any way other than in the best interest of their client. But, in that setting, we couldn’t necessarily call ourselves fiduciaries.”
When asked what advice they had for other planning teams that want to break out on their own, both Papazian and Keys mentioned watching the cost of building out office space.
Moving into a new building, they were allowed to specify what they wanted — from carpets and cabinets to walls and doors.
That left them walking a tightrope between setting up warehouse-style, which would be cost-effective but might feel jarring to clients accustomed to the elegance of Merrill, and spending every penny on glass offices and video walls.
They settled on nice, but not opulent.
“We didn’t want our clients thinking their money was going to pay for a marble entryway and cherry cabinets,” Papazian says.
But in retrospect, they acknowledge that it would have been a lot simpler and also cheaper to just lease a space that was already configured.
“We don’t regret it,” Keys says. “But it was one more ball of the 3,000 that we were trying to keep in the air.”