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Understanding Socially Innovative Investing

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Bank of America Private Bank is a long-time leader in sustainable and impact investing, or investing in stocks, bonds, exchange-traded funds and other investable assets, with the dual goals of making a profit and supporting societal or environmental progress. As the multi‐faceted benefits of incorporating environmental, social and governance (ESG) factors into investment strategies has begun to gain recognition among investors, sustainable and impact investing has become a more mainstream element of portfolio management, not only as a way to do good but also used in seeking enhanced risk‐adjusted returns. Our approach to sustainable and impact investing incorporates the full breadth of our wealth management capabilities and is achieved through the Chief Investment Office’s (CIO) offering of the Socially Innovative Investing (S2I) suite of strategies ― Environmental Stewardship Sustainability, Social Equality & Inclusion, Religious Voice & Values, Women and Girls Equality and Carbon Reserve Free.This suite of strategies is based in large part on the growing awareness that corporate leadership across a broad range of ESG criteria and strong financial performance are not mutually exclusive; rather, they can be mutually beneficial qualities. And while some companies engage in "doing good" just for the public relations value, all the CIO S2I strategies seek to invest in companies that are doing good because it can be good business and potentially lead to better financial performance over the long run.

THE ORIGINS

Sustainable and impact investing is almost inevitably rooted in an investor's personal values and beliefs. And while the approach has gained attention lately, versions of it have been around for a long time - At least since the mid-18th century, when Quakers banned followers from participating in the slave trade, individuals and groups have periodically chosen to avoid investments that conflict with moral, religious, environmental or other values. However, this approach, originally referred to as socially responsible investing (SRI), is notable for what it doesn't do. That is, investors choose what industries or companies not to invest in — such as weapons manufacturers and alcohol and tobacco producers, to name a few. And, because this "negative screening" entail limiting the universe of potentially profitable investments, it has often been viewed as more of a noble endeavor than a wise investment, with the investor likely to experience lower returns. Indeed, during the 1980s, Fortune magazine famously derided SRI as "feel good" or "politically correct" investing. Noted investment economist Milton Friedman even weighed in, stating in a New York Times article that the only goal for corporate managers should be maximizing profits, while anything less was a dereliction of duty to shareholders.

And, in fact, the performance experience of early social investors was mixed (at best), as portfolios often lacked appropriate diversification, fundamental analysis, and risk control. This perception was reinforced during the 2000s as a series of thematic investment strategies targeting alternative energy solutions was marketed as a new, environmentally conscious growth concept. But many of the companies were small, immature and speculative, with business models dependent upon a particular incentive program or regulatory regime. After a quick initial flurry of positive developments, these investment strategies floundered, and clients, understandably, headed for the exits. But times have changed, it seems.

THE EVOLUTION

With interest in social investing continuing to grow, a broader spectrum of strategies has evolved. These new approaches tend to be more active and demanding, more focused on profit and measurable impact, and based on the notion that strong ESG performance and corporate profitability are positively correlated. Enabling this expansion is an increasingly robust set of data that corporations publish in annual corporate sustainability reports. According to the Governance & Accountability Institute, over 85% of S&P 500 companies now publish such reports, up from just under 20% in 2011. Government agencies are also pressing for more regular and detailed disclosure from the companies they regulate. And industry groups such as the Sustainability Accounting Standards Board continues to ensure that data is reported consistently from company to company and industry to industry. As a result, investors now have access to a rich data set on workforce diversity, carbon emissions, water/energy usage, and waste, as well as the programs companies have invested in to better their communities and make a positive impact across their ecosystem.

Why is this new source of data so important? Part of the answer lies in the changing nature of the U.S. economy. During the 1970s, most of the value accruing to public U.S. companies was represented by tangible assets: machines, factories, inventory and so forth. But as we have shifted toward an information-driven economy, and as much of the nation's productive capacity has moved offshore, tangible assets have been largely superseded by intangible assets on the balance sheets of S&P 500 companies.

Indeed, intangible assets such as brand, reputation, supply chain, employees, intellectual property and customer base for S&P 500 companies in 2018 are at 84% - a rapid ascent.1 Investors can no longer rely exclusively on traditional financial analysis to evaluate the risks and opportunities facing today's tangible asset-light companies. But by including environmental, social and governance factors in their analysis, investors are better able to determine which companies are also effectively managing their (increasingly important) intangible asset base.

KEY DRIVERS OF VALUE

Measuring a company's actual commitment to these pillars involves a two-part review of stated policies and performance accountability. The S2I scoring process leverages over 400 unique data points designed to measure how effectively a corporation is engaging human capital, mitigating environmental impact and practicing good corporate governance.

Policy Review   Performance – Accountability Review*
  • Labor Management
  • Diversity & Inclusion
  • Human Rights & Supply Chain Management
Human Capital Engagement
  • Benefits & Compensation
  • % Women & Minorities
  • Equal Employment Opportunity (EEO) Fines
  • Water Conservation
  • Emissions, Effluents, Waste & Recycling
  • Climate Change
Environmental Stewardship
  • Water Use
  • Greenhouse Gas Emissions
  • Environmental Fines & Penalties
  • Board Independence & Structure
  • Control & Ownership
  • Compensation
Corporate Citizenship & Governance
  • Bribery & Corruption Controversies
  • Accounting Controls
  • Capital Deployment

*Examples of select factors.

FOUR MYTHS ABOUT SOCIAL INVESTING DEBUNKED

Many investors have focused on private, local and targeted investment opportunities to achieve impact and may view public equities simply as a source of investment income to fund their philanthropic efforts. But this often leads to misalignment between the investors' missions or values and a large portion of their financial assets. The CIO S2I strategies are designed to help investors to bridge that gap and achieve a more holistic approach to deploying capital. Furthermore, the most effective way to have impact on an established industry is often to invest in the leaders who have the influence, resources and long-term vision to improve business practices throughout the entire value chain.

To learn more about investment opportunities and opportunities and sustainable and impact investing portfolios, please contact the Socially Innovative Investing Team at dg.S2I_portfolio@bankofamerica.com.

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