Entries by Shane Enete, CFA

Ill-Wind Investing: Prudent or Profiteering?

As the Covid-19 crisis began to accelerate, my colleague proudly told me that he profited from buying Zoom stock. Another one of my friends boasted that he had made money selling short the stock market. Hearing these stories made me recall the words of the father from East of Eden, “Boys go out, and some die…do you think I could take a profit from that?”

“Boys go out, and some die…do you think I could take a profit from that?”

During late March, in a dark alley near Costco, there was a man selling toilet paper at marked-up prices. Seeing this man stirred in me two opposite reactions: anger for profiteering from other people’s suffering, and admiration for a man who was able to create a viable business model that both feeds his family and serves the community.

Which emotion should I feel when people make money from a pandemic: anger or admiration?

Ill-wind investing refers to making money on the account of “ill-winds” that sweep through a community, such as natural disasters, wars, or pandemics (Irvine, 2002). Is it morally wrong to make money from ill-winds?

Is it morally wrong to make money from ill-winds?

One simple way to argue against ill-wind investing would be to say that any activity that makes a profit from the suffering of others is morally wrong. While this may sound like a crystal clear rule to follow, it actually gets murky very quickly. For example, receiving an inheritance from an aunt who greatly suffered from Leukemia would be an example of a morally justified profit from the suffering of another person. Other murky examples include doctors who profit from ruptured spleens or boxers who receive money from knocking out their opponent.

Is it morally wrong to buy Zoom stock, short the stock market, or sell toilet paper at marked-up prices during a pandemic? One way to form a moral principle around this type of ill-wind investing would be to ask the question, “does this activity increase, have no effect, or diminish the suffering of others?” (Irvine, 2002).

Does this activity increase, have no effect, or diminish the suffering of others?

Regarding the Zoom stock, one could argue that it either has no effect, or actually diminishes the suffering of others. It is a good thing when the company of a needed product receives an increase in its stock value. Zoom’s access to capital, then, increases, helping the company expand its service to those in need.

Regarding shorting the stock market, one could argue all three cases. It may diminish the suffering of others by being a vehicle for greater price discovery. Price discovery, over a long period of time, helps to avoid destructive stock market bubbles. However, it may increase the suffering of others by encouraging a stock price drop that goes beyond price discovery. A stock market crash could then cause a panic that would cascade into business layoffs and premature retirement withdrawals.

Regarding selling toilet paper, it may diminish their suffering by being a provider of a needed commodity when every other provider, who is trying to be “fair,” has no more supply. It also may potentially increase the suffering of others by emptying the pockets of those who are at their most vulnerable financial state (perhaps unemployed, or furloughed).

Given that ill-wind investing is morally complex, Biblical wisdom, Holy Spirit discernment, and counsel from others is required. It is important to be fearful about making money from an event that is causing others to suffer. It is also important to look for ways to share any profit that is made with those who were not as fortunate.

“Your abundance at the present time should supply their need, so that their abundance may supply your need, that there may be fairness. As it is written, ‘Whoever gathered much had nothing left over, and whoever gathered little had no lack.’” 2 Corinthians 8:14-15, ESV.

There is a story about a man who would walk a mile to work everyday. His one mile walk was his favorite part of the day. One day he happened to look down at a gutter and found a five dollar bill. The man was so thrilled about finding the five dollar bill, that the next day he couldn’t help but peer into every gutter on his way to work. In fact, for the rest of the year, he spent most of his one mile walk staring at gutters.

Even if ill-wind investing is morally acceptable, if we do not watch our ways, we may actually spend our lives “staring at gutters” as we try and find ways to continue to make money from the ill-winds of global warming, pandemics, hurricanes, and droughts. And, if we are not careful, we may slip into a terrible place; namely, hoping that more ill-winds would happen so that we could make even more money.

If we are not careful, we may slip into a terrible place.

Investing is not just a matter of the mind and the wallet, but also of the heart and the community. When we invest in a business venture, it is important to consider the impact that it will have on our community and our hearts, as well as on our wallets. Do our investing opportunities diminish human suffering? When we invest, we should strive to enter into investing opportunities that bring about prosperity for both ourselves and our community.


REFERENCES

Irvine, W. B. (2002). Ill-Wind Investing: The Ethics of Wishing. Journal of Business Ethics, 35(1), 57–63. JSTOR.

Using Behavioral Finance To Understand The Necessity Of Quarantine

With every drop in GDP from the quarantine, my stomach drops, as well. I can’t help but ask myself, “is this the right way to go? As a Christian, I would like to submit to the authority of the government (Romans 13), but what if their policies are overly destructive, like cutting off our hand to fix a paper cut? What about the idea of ‘herd immunity’ where we are all exposed to the virus, all-at-once, and get done with it? With no more curves to flatten in the future?”

There has to be a better way than quarantine.

Even though I really have no valid voice in questioning the policies of the CDC, I will provide my perspective as a finance professor. Looking at behavioral finance may actually provide evidence in favor of the quarantine. For many years, I have conducted the following behavioral finance thought experiment with my students from recent Nobel Prize winner in economics, Richard Thaler (Thaler & Ganser, 2015). 

Please respond to the following two scenarios:

A. Suppose by attending a lecture you have exposed yourself to a rare fatal disease. If you contract the disease you will die a quick and painless death sometime next week. The chance you will get the disease is 1 in 1,000. We have a single dose of an antidote for this disease that will sell to the highest bidder. If you take this antidote the risk of dying from the disease goes to zero. What is the most you would be willing to pay for this antidote? (If you are short on cash we will lend you the money to pay for the antidote at a zero rate of interest with thirty years to pay it back.)

B. Researchers at the university hospital are doing some research on the same rare disease. They need volunteers who would be willing to simply walk into a room for five minutes and expose themselves to the same 1 in 1,000 risk of getting the disease and dying a quick and painless death in the next week. No antidote will be available. What is the least amount of money you would demand to participate in this research study?

Consistent with what Richard Thaler found in his experiments, my students tended to have dramatically different responses between scenarios A and B. In fact, many of my students would refuse to participate in scenario B (even though it was a thought experiment). Having dramatically different responses to scenario A and B is known as the endowment effect.

The endowment effect has applications in finance by showing that sellers often think that what they own is worth more than its true fair market price simply because it is owned by them (i.e., it has become a part of their endowment). A classic example of this is when investors hold onto stock losers too long (Kalunda & Mbaluka, 2012).

This same effect may explain why a preemptive quarantine is the best strategy for policymakers to enact. If everyone was asked to essentially become exposed to the Covid-19 virus all-at-once, for the sake of Herd immunity, that would be very similar to asking them to participate in scenario B. Put another way, herd immunity is similar to scenario B since it asks people to voluntarily expose themselves to a rare disease in order to be compensated in the form of higher future expected economic wealth for our country. The final result of this would be, just like with scenario B, a refusal by a majority of people, and these people would likely self-quarantine.

Quarantine does not ask people to enter into scenario B.

A delayed self-quarantine is a much more disastrous scenario than an early, government sanctioned quarantine for the following reasons: 

  • The delay in quarantine would increase the number of cases, which would then overwhelm the healthcare system, causing thousands of people to die without hospital beds or sufficient care.
  • A very similar economic loss would occur (perhaps worse) than if the government sanctioned a preemptive quarantine.
  • Having both the hospital system become overrun and the government entities enact a system that people will fundamentally not follow would cause a deep distrust in two of the most important institutions in our society. This would cause a rip in our social fabric. 

Our current policy does not ask people to be a part of scenario B. This is good. It means that some level of faith is able to be maintained in both our health-care system and in the government’s authority; even while our economies experience heavy losses. 

While I may agree, or disagree, with the policies of the kingdoms of this world, as a Christian, I am called to seek His Kingdom first (Matthew 6:33). Through this Covid-19 crisis, God’s Kingdom has not experienced any drop in heavenly GDP. In fact, His Kingdom is likely advancing at a more rapid rate than before, as our idols of self-autonomy and independence are toppled. 

Which kingdom do I want to prosper more? If I am desperate for my kingdom to prosper, and mildly interested in God’s Kingdom to prosper, then I am not walking as Jesus calls me to walk.

Which kingdom do I want to prosper more?

During this time, as good, or bad, human policies come and go, the words of Jesus should be at the forefront of my mind:

“In the world you will have tribulation. But take heart; I have overcome the world.” (John 16:33, ESV)”


REFERENCES

Kalunda, E., & Mbaluka, P. (2012). Test of endowment and disposition effects under prospect theory on decision-making process of individual investors at the Nairobi securities Exchange, Kenya.

Thaler, R. H., & Ganser, L. J. (2015). Misbehaving: The making of behavioral economics. WW Norton New York.

Performance Attribution of the First Biblically-based SRI Index

SUMMARY

A recent study by Shane Enete, CFA at the Biola University Inspire Research Institute For Biblically Responsible Investing (BRI), has shown that applying the Inspire Impact Score methodology to portfolio security selection generated alpha in a portfolio when compared to the broader, non-Inspire Impact Score screened benchmark. This finding adds new data to the debate of what effect values-based screening (Socially Responsible, Biblically Responsible, ESG, etc) has on the performance of a portfolio.

At Inspire we believe that good values and good returns are not mutually exclusive, and the findings from this study validate that belief. While screening a portfolio does not guarantee alpha generation, this study clearly shows that using the Inspire Impact Score methodology does have the potential to provide outperformance when compared to a non-screened benchmark.

ABOUT THE STUDY

For the purposes of this study, a traditional attribution analysis method was applied to the Inspire Small/Mid Cap Impact Equal Weight Index (”Index”) over a five year period. The study compared the contribution to overall returns from three variables:

1) Equal weight composition;
2) Sector bias; and,
3) Inspire Impact Score security selection methodology.

These three variables were then isolated and compared against the benchmark to determine the effect each individual variable had on overall performance.

“The results of the study found that the Inspire Impact Score methodology of security selection resulted in an annualized 4.7% outperformance compared to the non-screened benchmark.”

Performance data chart

Figure 1 – SP500

The remaining variables of sector weighting and equal weight composition had a negligible effect on the overall performance. (See Fig. 1) These findings pave the way for additional research into the underlying reasons as to why companies with higher Inspire Impact Scores provide the potential to outperform companies with lower Inspire Impact Scores, and the Biola University Inspire Research Institute for BRI is up to the task, but what is clear is that companies that are a blessing to their customers, communities, workplace and the world have the potential to outperform their peers and that investors who are seeking to create profit and impact do not necessarily need to resign themselves to substandard returns. Indeed, it is possible that they could experience above-average returns by including Inspire Impact Score screening in their investment strategy.

 

 


Performance Attribution of the First
Biblically-based SRI Index

Shane Enete, CFA
Biola University

Working Draft

Abstract

In the U.S., two of the most important investment trends over the last 10 years have been the rise of index investing and the rise of Sustainable, Responsible and Impact (SRI) investing. So, it would make sense that new indexes would emerge based on SRI principles. One such index is the new Inspire Small/Mid Cap Impact Equal Weight Index, which is the first biblically-based SRI index. This paper briefly discusses the methodology of this index and shows that its strong back-tested risk-adjusted returns (relative to its non-SRI S&P benchmark), are not due to sector bias (as one would expect), but are attributed to favorable stock selection within each industry sector. This index is likely the beginning of a wave of more sophisticated passive products that will meet the needs of niche investor populations better than the active products of the past.

I. Introduction

In the U.S., two investment trends have been dramatic over the last 10 years:

  •  the rise of index investing, and
  •  the rise of Sustainable, Responsible and Impact (SRI) investing

As of 2016, flows from active to index funds have surpassed one trillion dollars and SRI Investing has achieved $9 trillion of assets under management (see Figures 1 and 2).

So, it would make sense that these two trends would collide and new SRI indexes would emerge. One such index is the Inspire Small/Mid Cap Impact Equal Weight Index. This index has a unique faith-based construction that has performed well relative to its non-SRI S&P benchmark. This is likely the beginning of a new breed of indexes that will serve niche investors better than previous active products of the past.

Figure 1: Mauboussin, Michael, J., Dan Callahan, and Darius Majd, “Looking for the Easy Game,”Credit Suisse, 2017,
Figure 2:
U.S. SIF Foundation

II. Index Construction

Unlike most existing SRI indexes2, this index focuses on small-to-medium companies, weighting its index constituents equally3. In addition, this is the first passive SRI product that explicitly ties the construction of its index to a biblically-based worldview, in particular, a reformed, non-denominational Christian worldview that emphasizes traditional Biblical views on all environmental, social and governance issues. Although applying a Christian worldview to active investing products has been done for more than 100 years4, this is the first passive index based on “Biblically Responsible Investing” (BRI) principles to be introduced to the financial markets. The Inspire index is constructed using an Impact Scoring methodology that essentially overweights companies that are aligned with biblical values and excludes companies that are not aligned with biblical values. Companies with a high Impact score may have one or more of the following characteristics:

  • inspiring primary business activity that uplifts society
  • positive environmental policies
  • support biblical values through philanthropy
  • operate with a perceived high level of integrity

Companies that have a low Impact Score would likely be involved in the enabling of certain types of activities that are contrary to what the Bible says will enable human flourishing, such as abortion, pornography, labor abuse, non-traditional family values, and gambling.

2For example: MSCI’s KLD 400 Social Index, FTSE’s 4Good Index Series, Calvert’s Social Index, Dow Jones’Sustainability Index
3Chow et al., (2011), found a significant improvement in returns when equally-weighting an index (versus marketcap weighting)
4During the late 1800s, the Quakers and the Methodists followed investment practices that prohibited investing in companies that were involved in slavery, smuggling and conspicuous consumption

 

III. performance

i. Risk-adjusted Returns

Probably the biggest criticism of SRI investing is that  constructing a portfolio from a restricted universe of opportunities will impose too great a cost on the portfolio’s risk-adjusted returns, relative to their unrestrained counterparts. In other words, when trying to “do good,” there will be too heavy a cost on the portfolio.

When looking at the Inspire Small/Mid Cap Impact Equal Weight Index, early indications show a possible positive risk-adjusted performance benefit when using Inspire’s Impact Scoring methodology to construct their index. From 2012 to 2016, the Inspire index outperformed an equally weighted 50/50 blend of the S&P 400 and S&P 600 by over 4%, on an annualized basis, while maintaining a similar standard deviation.

This back tested performance result is not inconsistent with many academic studies over the years, which have shown that there is either a neutral or small benefit to risk-adjusted performance when adding different types of
SRI criteria to the managing of an investment product.5

5Revelli, C. and Viviani, J.-L. (2015), Stone et al. [2002],

ii. Attribution

Another significant criticism of SRI investing is that sector bias is really what drives the performance. DiBartolomeo and Kurtz [1999] demonstrated that the positive outperformance of one of the oldest SRI indexes, the Domini 400 Social index, was largely due to economic and sector exposures that are the result of the screening process itself.

It would make sense that certain sectors, like oil and gas, would naturally “screen themselves out” of most SRI indexes looking to protect the environment. So, given the possibility of sector biases embedded in SRI products, should it be assumed that any outperformance relative to a benchmark is simply due to large
“sector bets” that happen to go in the favor of the SRI index?

When conducting a performance attribution on the Inspire index relative to the S&P benchmark, there is no evidence that sector bets contributed to the outperformance.6

6Using the BHB model for attribution (Brinson, Hood, and Beebower, 1986). GICS sectors were used for the S&P benchmark; However, for the Inspire index, the sectors were first determined using The Industrial Classification Benchmark (ICB) sectors and then they were unofficially mapped to a GICS sector manually. An “Other” sector was used, which primarily represents the Real Estate sector, which was carved out of the S&P Financials sector during September of 2016. The small difference in alpha between tables 1 and 2 (4.4% vs. 4.2%) is due to rounding errors associated with the attribution methodology

IIV. Conclusion

Given the continued popularity of both passive index and SRI investing, new SRI indexes will likely proliferate during the next couple of years. The creation of the Inspire Small/Mid Cap Impact Equal Weight Index is the beginning of a wave of more sophisticated passive products that will better meet the needs of niche investor populations (e.g., faith-based investors) than the high-fee active products of the past.

references

[Bauer, Koedijk, and Otten, 2005] Bauer, Rob, Kees Koedijk, and Roger Otten (2005). “International Evidence on Ethical Mutual Fund Performance and Investment Style.” Journal of Banking and Finance , 29-7 (2005), pp. 1751-1767. (as cited in Milevsky et al., 2006).

[Brinson, Hood, and Beebower, 1986] Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. (1986). “Determinants of Portfolio Performance,” Financial Analysts Journal , vol. 42, no. 4 (July/August):39:44.

[Chow et al, 2011] Tzee-man Chow, Jason Hsu, Vitali Kalesnik, and Bryce Little (2011). “A Survey of Alternative Equity Index Strategies” FAJ, Volume 67,5, 2011

[DiBartolomeo and Kurtz, 1999] DiBartolomeo, Dan, and Lloyd Kurtz (1999). “Managing Risk Expo- sures of Socially Screened Portfolios.” Northfield Information Services. (as cited in Milevsky et al., 2006)

[Goldreyer, Ahmed, and Diltz, 1999] Goldreyer, Ahmed, and Diltz (1999). “The Performance of Socially Responsible Mutual Funds: Incorporating Sociopolitical Information in Portfolio Selection” Managerial Finance , 25-1 (1999), pp. 23-3. (as cited in Milevsky et al., 2006).

[Guerard, John B., Jr., 1997] Guerard, John B., Jr. (1997). “Is There a Cost to Being Socially Responsible in Investing?” TheJournal ofInvesting , 6-2 (1997), pp. 11-18. (as cited in Milevsky et al., 2006).

[Hamilton, Jo, and Statman, 1993] Hamilton, Sally, Hoje Jo, and Meir Statman (1993). “Doing Well While Doing Good? The Investment Performance of Socially Responsible Mutual Funds.” Financial Analysts Journal , 49(6) (1993), pp. 62-66

[Milevsky et al., 2006] Milevsky, Moshe, Andrew Aziz, Allen Goss, Jane (Thomson) Comeault and David Wheeler (2006). “Cleaning a Passive Index” Journal of Portfolio Management , Spring 2006:110-118.

[Revelli, C. and Viviani, J.-L., 2015] Revelli, C. and Viviani, J.-L. (2015). “Financial performance of socially responsible investing (SRI): what have we learned? A metaanalysis.” Business Ethics: A European Review , 24: 158:185. doi: 10.1111/beer.12076.

[Stone et. al, 2002] Stone, Bernell K., John B. Guerard, Jr., Mustafa N. Gultekin, and Greg Adams (2002). “Socially Responsible Investment Screening: Strong Evidence of No Significant Cost for Actively Managed Portfolios” Working paper, Marriott School of Finance, Brigham Young University, October 2002. (as cited in Milevsky et al., 2006).

A Biblical Argument for BRI

“A Biblical Argument for BRI” is a paper from the Inspire-Biola Research Institute for Biblically Responsible Investing written by Shane Enete, CFA.  Read the full paper below:  


A Biblical Argument for BRI

By Shane Enete, CFA

Assistant Professor of Finance, Biola University

In the beginning, God’s commandment for us is to work and watch over the land (Genesis 2:15).

While our culture has excelled at becoming more productive in our “working of the land” through modern portfolio theory and passive investing, we have gradually gotten worse at fulfilling the second part of God’s commandment, namely, to “watch over” the very land that we are working.

Christian investors can respond to this weakened ability to watch over the land by moving towards Biblically Responsible Investing (BRI).

In the beginning, “the LORD God took man and put him in the garden of Eden to work it and watch over it.” (Genesis 2:15, NLT, emphasis added) This is a Biblical framework for how investing should be. 

To “work the land” effectively means to enable it to produce fruit. 

To “watch over the land” effectively means to enable the garden to flourish in the midst of its fruit production. 

Since Christian investors do not necessarily find themselves with hands full of dirt as they work and watch over our world, does this mean this early job description from the Lord does not apply to a Christian investor today? How could working and watching over the land be done well for a Christian investor today?

The Biblical Argument For BRI

Work The Land

Over the last 400 years, a few key financial ideas have enabled an abundant working of the land.

For this paper, I am going to highlight three such financial ideas that have particularly helped us harvest fruit from the land: the jointstock company (1609), modern portfolio theory (1952), and passive investing (1990s)

The first crucial financial idea that allowed for a great increase in the fruitfulness of the land was the invention of the joint-stock company. A joint stock company is its own legal entity, which allowed investors to buy “shares of stock” in that independent company. The first Joint-Stock company was the Dutch East India Company in 1609.

Before the joint-stock company, any investor who wanted to invest in a company needed to become a partner of that company, which entailed a lot of paperwork and commitment. And if the investor wanted to sell his partnership position, more paperwork (and often lawyers) were needed to get out of the partnership.

One of the greatest features of owning stock in a joint-stock company was that the owner is free to sell that share of stock to any willing buyer without needing any kind of permission by the company.

Once the joint-stock company was created, money was pooled together more easily. This injected significant “liquidity” into the financial markets.

But, it was not until the large scale adoption of modern portfolio theory (MPT) that stock investing was moved from the halls of the rich to the living rooms of the common citizen.

MPT, first articulated by Harry Markowitz in 1952, argues that an investor should not put all of his or her eggs in one basket.

While this may seem like a simple concept, the revolutionary idea of MPT was that all investment opportunities should not be considered just individually, but also be evaluated together as a potential portfolio. Evaluating all investment opportunities in the context of a portfolio led the average risk-conscious investor to include stocks in their investment accounts, which eventually led to billions of dollars of retirement money1 being injected into the stock market.

The last powerful financial idea that I will mention, which served to further enhance the fruitfulness of the land, was the invention of “passive investing.”

Passive investing is when investor money is pooled together and then given to a computer that simply buys a “list of companies” (i.e., index). An index can represent exposure to any kind of desired business risk (e.g., oil companies, car companies, European companies).

Since the holdings of the index list are mostly stationary, the portfolio is not actively managed, and is said to be “passive.”

Bill Sharpe wrote a paper in 1991 called, “Arithmetic of Active Management” where he showed the simple math that, given the laws of arithmetic, half of all money managers will earn less than average returns (less than half when you subtract management fees).

By comparison, passive funds, which have minimal costs2 , should be expected to outperform most professional managers. This logic has consistently proven to be true by academic research. For example, one recent study showed that passive funds outperformed 76% of active mutual fund managers from 2003-20133.

Given the simplicity and cheapness of passive investments, investors have stampeded towards passive products and these passive products have led to widespread ownership of stocks by American households (55% of all U.S. households4, 66% of all 401k assets5, more than half of all U.S. public pension money are invested in stocks as of the mid-2000s).6 This increase in stock ownership means companies produce more goods and services since they have more access to capital for their business ideas.

1 Smith, Mark B., Equity Culture, Farrar, Straus and Giroux, New York, 2003 (pg. 219-220)

2 The most popular passive product, Vanguard’s S&P 500 Index has an annual fee of 0.05% vs. 1.0% for the average active fund.

3 https://www.nerdwallet.com/blog/investing/investing-data/activemutual-fund-managers-beat-market-index/

4 Gallup’s annual Economy and Finance survey, 2015

5 As of 2014, https://www.ici.org/pdf/per22-03.pdf

6 Pension and Investments 2012 annual plan sponsor survey

Watch Over The Land

As the world economy has proliferated in goods and services, there has been a trend of less and less monitoring of those goods and services. To watch over the land means to understand the impact of our goods and services on the community. Before the joint-stock company, modern portfolio theory, and passive investing, owners of businesses had a shared liability with their business – if the business acted in a way inconsistent with the owners’ values, all investors in that company were legally liable, so investors put a high value on monitoring their investments.

If we fast-forward to today, it is a much different story. Because of the limited liability of owning a stock (no stock owner can lose more than their initial investment) and the lower risk of owning a portfolio of stocks, owners of stock typically own hundreds of companies.

Managers, who receive investor money from thousands of different stock investors, are no longer working alongside their investors.

One of the most serious consequences of this trend is that Christian stock owners, who often own hundreds of companies, may not know when their owned investments engage in activities that deteriorate human flourishing, such as funding abortion clinics or pornographic products.

One of the most popular investment products, the Vanguard S&P 500 Index, with $443 billion dollars of investor money, includes many companies who are acting directly against Biblical values. eValueator estimates that 73% of the 500 companies in the fund are acting in ways not consistent with Biblical values.

Christians need to do a better job of watching over their investments and ensuring that they are not endorsing (or profiting from) certain corporate behavior, through their stock ownership claims, that help to lead culture away from Biblical values.7

So, what is a Christian to do, then? Is the only solution to disengage from passive investing, altogether?

7http://evalueator.com/ (as of 8/3/16)

Our Response

One simple solution is to move towards Biblically Responsible Investing (BRI). BRI is a movement of biblically inspired investment products that are able to combine the positive benefits modern portfolio theory and passive investing with a consciousness that these products need to be “watched” to ensure that Christian values of stewardship are being honored.

These BRI products are “watched” through their endorsing, engaging and excluding activities; they endorse companies that are acting especially consistent with biblical truth, but also engage and/or exclude companies that are not acting in ways consistent with Biblical truth.

While this type of “watching over” will always fail to be as effective as a single shared liability business investment, it is a step towards fulfilling God’s mandate to both work and watch over the land that has been entrusted to us.

Merits Of Equal Weighting An Index

What is the best way to cook an egg?  Scrambled?  Fried?  Poached, perhaps?  That is, of course, an impossible question because the correct answer is completely dependent on what you want the end result to be.

The same is true with index construction.

What is the best way to build an index?  Market cap weighted?  Sector weighted?  Equally weighted?  Or maybe one of the other myriad smart-beta strategies prevalent in the market today?  The right answer depends completely on what you want the characteristics of your finished product, in this case the index, to be.  Are you after lower volatility?  Higher growth?  Broader diversification?

Amid all of these potential strategies, it is one of the simplest, oldest, and elegant that quite possibly is also one of the most beneficial:  the equally weighted index.

In this paper written by Shane Enete, CFA, with Biola University’s Inspire Research Institute for Biblically Responsible Investing, you will be introduced to the history of indexing, how the “traditional” indexes came to be and why there might be a better way.

READ THE FULL PAPER HERE

 
 

 

Inspired Investing: An Introduction To Biblically Responsible Investing

Inspired Investing

An Introduction to Biblically Responsible Investing (BRI)


By Shane Enete, CFA

Assistant Professor of Finance, Biola University

Biblically Responsible Investing (BRI) is a growing movement among Christian investors and investment firms, with significant potential for cultural impact. BRI is an investing approach that seeks to ensure that a Christian is investing in a way that is consistent with the moral standards of the Bible. Is BRI a helpful  investment approach? Or just a marketing ploy meant to exploit?

As this paper will argue, BRI products, through their excluding, engaging and endorsing activities, help Christian investors maintain their integrity and responsibility to biblical stewardship while actively investing in the stock market.

Discovering BRI

There is a growing movement among Christian investors to align their investments with biblical values. This movement is called Biblically Responsible Investing (BRI) and it is on the rise. But is BRI just a marketing gimmick designed to prey on Christians who see the word, “Bible,” and automatically direct their money to it without any thought about investment prudence?
The answer is clearly “no” when the implications of being a stock owner are fully understood.

Stock Ownership Is Business Ownership

In order to understand the implications of being a stock owner, it is good to define what stock ownership really means. “Shares of stock” are certificates of ownership that an investor receives in exchange for investing money in a corporation.

 

“If you are a stock owner, you are a business owner.”

Once a corporation receives money from investors, the corporation buys “assets” (e.g., machines, land, property, etc.). These assets are then “managed” by managers who receive a salary so that they will, hopefully, be able to generate a profit while managing those assets. This profit belongs exclusively to the stock owners

For example, if a lemonade company received $250 from an investor, the company would hire a manager to buy a lemonade machine and some lemons, which they hope will generate sales that are in excess of expenses (i.e., profit).

So, given that stock owners “own” the profits of a company, then this would mean that a stock owner is a residual owner of the business, effectively making a stock owner a business owner.

However, most stock owners either do not know they own businesses, or really do not believe this is true. Perhaps this is because, for most companies, there are millions of other stock owners, so it seems like each individual ownership claim is too insignificant to be an actual ownership claim. But that is not true: Ownership is ownership, whether small or large.

One of the clearest signs that a shareholder is a business owner is that shareholders are asked to vote on all important company matters. Shareholders receive voting packets in the mail every quarter, and to vote is to be counted as a member; or, put another way, to cast your vote means you have certain rights within that company
that you are exercising, which were given to you through stock ownership.

Shareholders also receive dividends, which are company profits. This is the most important part of being an owner: entitlement to the company’s profits. As a company’s assets generate profits, they accrue to the owners of those assets.

1 A Comprehensive Dictionary of Psychological and Psychoanalytical Terms

Losing Integrity

There is a certain pride in owning, and profiting from, companies that are making great products (e.g., automobiles) and providing great services (e.g., hospital care). But, what if a company is not acting in a way that an individual would deem “responsible to society”?

For example, what if an individual had a strong moral conviction that it is not responsible to society to slaughter cattle for meat consumption? It would not be a source of pride for that individual to accumulate the profits of McDonald’s. In fact, if this individual discovers that they own McDonald’s, and continues to accumulate McDonald’s’ profit, that individual will eventually lose their integrity.

Integrity is defined as “the quality of being whole or undivided; moral consistency; honesty and truthfulness.”1  integrity comes from the word, “integer,” as in, whole number. When a person loses integrity, they become fractured; they are no longer a whole number.

One of the big psychological consequences of losing integrity is the gradual erosion of our sense of self.2

Many investors are at risk of losing their integrity.

The moment of truth comes when, as business owners, they actually look at what businesses they own. At that point they will need to make decisions about whether they want to continue to profit from certain companies that violate their internal sense of morality or stay true to their moral convictions. For example, a third-party values-based screening company, evaluator, recently released a list of 77 companies that directly fund Planned Parenthood.3

Many of these companies are members of the S&P 500 index, which means that the vast majority of investors in the world own at least a few of these companies. If an investor believes strongly that abortion is the destruction of human life, then to willingly receive the profits from companies that are helping fund abortions is evidence that this investor’s sense of self is eroding since they are not acting in a consistent way with their internal convictions. Another example would be Microsoft and their video game division, which sells three games that have graphic nudity. If an individual has a strong moral conviction that pornography harms society and they own shares in Microsoft, they are actually helping to finance the production of pornographic content, and sharing in the profits as well.

2http://www.docdreyfus.com/psychologically-speaking/integrityrelationships-and-your-mental-health-part-2-of-3/

3http://evalueator.com/download/77_Companies_Funding_Planned_Parenthood-LD.pdf

4 Games include: “Ryse: Son of Rome” (2013), “Fable III” (2011), “Fable II” (2008).

Strong Moral Convictions

So, what is an investor supposed to do? If the investor has weak convictions about moral issues, then there is not much that needs to be done; this investors’ integrity is not threatened by questionable corporate activity. But, if an investor has strong moral convictions, action should be taken. And for a Christian, action must be taken.

A Christian has a strong sense of moral conviction that is derived from the words of the Holy Bible. The Bible lays out a way of life that is considered “life and light” (i.e., truth) and, also, a way of life that is considered “death and darkness” (i.e., untruth). A Christian of high moral convictions will seek to “walk in the light” while “fleeing the darkness.” The loss of integrity would be the greatest for the Christian who has the strongest ideas of what is good and true, and does not act in accordance.

Or put another way, because light and darkness are well defined by the Bible, the Christian who acts in a way that is inconsistent with the truth that they know (i.e., taking the profits from a company that is profiting from abortions), will be the most at risk of losing integrity.

But, the reason to act for a Christian is not simply to maintain their integrity, it is to honor their Lord and Savior and their responsibility to Him to manage His assets according to His will for His glory.

The Owner of All Things

One of the truths set out in the Bible is that the Creator of the Universe, God, actually is owner of all things.

“Thus says the LORD: ‘Heaven is my throne, and the earth is my footstool; what is the house that you would build for me, and what is the place of my rest? All these things my hand has made, and so all these things came to be, declares the LORD. But this is the one to whom I will look: he who is humble and contrite in spirit and trembles at my word.'” Isaiah 66:1-2, ESV

This adds another layer to the investing conversation, because they are also stewards (i.e., managers) of what God owns. If this is true, a Christian that invests God’s money in a company that produces pornography has acted as a very bad manager, doing the very thing that God would not want to do with His money. If this is happening with the Christian’s full knowledge, there is a fundamental failure of that Christian’s Biblical stewardship responsibility — they are not acting like a good steward.

Therefore, when a BRI product helps a Christian take seriously their role as steward of God’s money through a combination of divesting, engaging and endorsing, that BRI product is serving the investor in a very meaningful way.

Besides protecting a Christian investors’ integrity and sense of biblical stewardship, the BRI product is also able to serve culture in a positive way. BRI gives Christian investors the opportunity to use their ownership influence to bring about positive cultural change. Many corporations take public (and non-public) stances on cultural issues such as abortion and gay marriage.

Many such corporations take these positions not because they are actually passionate about the cause, but rather because a special interest group is lobbying them and they think it is a good business decision to promote that cause. BRI provides a voice. This voice becomes more able to get the attention of corporations as more Christians invest in BRI products.

The BRI movement has already produced some important cultural changes in recent years, a few of which are listed below:

  • Exxon ends abortion philanthropy (2013)
  • Home Depot ends corporate LGBT activism (2014)
  • Hilton removes pornography from their hotels (2015)
  • Abercrombie and Fitch eliminates sexualized marketing (2015)
  • Chevron ends abortion philanthropy (2015)

1 A Comprehensive Dictionary of Psychological and Psychoanalytical Terms

Taking Action

Biblically Responsible Investing products are constructed in a way that is consistent with biblical truth. These products achieve a “consistency” with biblical truth by doing at least one of the following three things:

  1. Endorse companies that are acting especially consistent with biblical truth.
  2. Engage with companies that are acting in ways not consistent with biblical truth through shareholder activism, with the hope of changing the company’s behavior.
  3. Exclude companies that are acting in ways not consistent with biblical truth. It is important to note that many BRI investment products attempt to do a combination of all three of these activities, and excluding, engaging, and endorsing are, in many ways, complementary activities.

1) Endorse

One of the most fulfilling aspects of BRI is to reward companies that are especially living out biblical truth in how they operate by investing in their stock. What does it mean to live out biblical truth well? It is more than just avoiding what is “bad.” It is acting out the greatest commandment of the Bible, which is “to love God and love your
neighbor as yourself.”(5) Currently, the desire to endorse companies “loving God and their neighbor well” expresses itself in two different ways in the investment marketplace: (i) Impact Investing, or (ii) Best-in-Class Investing.

 

(i) Impact Investing

The first expression, known as Impact Investing, focuses on making investments that will specifically help to solve a social or environmental problem.

Examples of impact investments include:

  • Xylem (ticker: XYL), a publicly traded water infrastructure company, seeks to ensure that the world, particularly the poor, will have adequate access to water through the use of their technologies. Their vision is that they will use their technology, time and talents to help advance the “smarter” use of water.
  • A EUR 150 million European private equity fund invests between EUR 2-10 million in companies that provide clean electricity to rural communities in developing countries with limited access to energy.
  • A $65 million U.K. fund invests in a Fair Trade and organic-certified coffee cooperative located in Ecuador.

For more examples of impact investing, ImpactAssets 50 provides a selective list of 50 investment management firms that are engaged in impact investing and what they are doing.6

 (ii) Best-in-Class Investing

This second expression of endorsing companies “loving God and their neighbor well” is called Best-in-Class Investing, which focuses on only buying the companies within every sector that are leading the way in social, moral, and environmental behavior.

For example, a “best-in-class” BRI product that is seeking to be excellent to the environment could still own an oil company, as long as they are endorsing the oil company that is the most environmentally friendly, and, through their support of that company, encourage the rest of the industry to improve their environmental policies.

2) Engage

While selling (i.e. divesting) “what is bad” is the most common reaction by Christians to owning companies that violate Biblical truth, “engaging” these companies should have a better chance of creating corporate change.

The most famous divestment movement in the U.S. was the divestment of all South African companies in the 1980s during the anti-apartheid movement. This movement resulted in hundreds of investors publicly divesting from South African companies in order to put public pressure on them to change their apartheid ways. Siew et al., (1999) study showed that, while there was a lot of publicity that resulted from this movement, there was no discernible impact on the market valuations of the divested companies.

All that appeared from this movement was that shares were exchanged from “investors of conscience” to investors who were more morally neutral. Therefore, while divestment may be the most natural response to owning morally controversial companies, many BRI investment products have chosen to engage corporate management of these companies before divesting in order to see if they might first change their behavior.

Some examples of successful shareholder engagement (also known as shareholder advocacy):

  • In 1997, a Christian shareholder of General Mills, Kleinbrook, discovered that the company had been directing corporate money to Planned Parenthood. Instead of simply divesting General Mills (ticker: GIS) stock, Kleinbrook organized investors and put enough pressure on management to change their policy.7
  • In 1999, Home Depot announced that they would phase out sales of products made from woods harvested in old growth forests. This happened after about three years of shareholder dialogue. During that time a series of meetings between environmentalists, concerned shareholders, and management took place.8 In 2015, Hilton announced that they are no longer going to offer pornographic films in their hotels in response to pressure from Christian investors.9

Interestingly, the majority of shareholder engagement today is by faith-based investors (see pie-chart).

6 http://www.impactassets.org/publications_insights/impact50
7 Naber, Mary (2006), “Christ’s returns,” Christianity Today; Sep 3, 2001; 45, 11; ProQuest pg. 78
8 Domini, Amy (2001), Socially Responsible Investing, Dearborn Trade, 2001
9 http://christianwm.com/inspire-mission/hilton-says-no-more-pornography/

3) Exclude (i.e., Divest)

The most common BRI products simply exclude companies from their portfolios that are not consistent with biblical truth, and for the investor who does not have the time or expertise to endorse or engage, this is a valid method of upholding biblical values and maintaining integrity as a Christian.

Investment products centered around divestment are nothing new; in fact, this practice is as old as stock investing itself. As early as 1696, the Quakers advocated against investing in the slave trade through such companies as the Dutch East India Company, which being founded in 1602, was the first company ever to issue shares of stock.10

In the U.S., the Pioneer Fund Group established a fund that refused to invest in companies that were involved in alcohol or tobacco as early as 1928.

Subsequent divestment movements (e.g., anti- Vietnam War, anti-apartheid in South Africa, anti-Sudan, anti-greenhouse gases) have created an ample amount of investment products for investors seeking to invest in the stock market while also avoiding areas of moral controversy.

Typical BRI products will screen out companies which support or profit from the following issues: abortion, pornography, LGBT activism, human rights violations, anti-family entertainment, alcohol, tobacco, gambling.

Some investment products also include additional issues, such as environment, weapons, and corporate pay.

For a quick reference of the prevalence of corporate support for unbiblical issues such as these, see the table above, which lists a sampling of large U.S. companies (from the Dow Jones Industrial Average Index), showing how many of them are engaged in activities that are not consistent with biblical truth.

While this list may seem discouraging, the good news is that the overwhelming majority of publicly traded stocks pass biblical screening criterion.

Violations such as illustrated below are mainly concentrated in the largest companies, while small and mid-sized companies tend to be much less egregious as a group. In addition, even within the large company space there are still plenty of options: out of the 500 stocks in the S&P 500, 247 pass biblical screening criterion.11

10 Bohoslavsky, Juan P. and Jernej Letnar Cernic (2014), Making Sovereign Financing and Human Rights Work, Bloomsbury Publishing, pg. 324

11 Source: Inspire Large Cap Impact Indexpg. 324

Common Questions

While BRI is an attractive proposition for most Christians, there are a couple common questions that give some investors pause:

  1. Does BRI deliver lower returns due to a restricted investment universe?
  2. Are there an adequate number of BRI investment options available to invest prudently with sufficient diversification?

Question #1: Does BRI mean lower returns?

A common objection to BRI investing is that an investment strategy that divests large amounts of companies from the investable universe will limit their ability to earn a reasonable return. The rationale for this fear is that by reducing the possible investment opportunities, it is likely that many good investment opportunities will be missed. However, through numerous research papers over the last 10 years, this objection does not appear to hold up.

Revelli, C. and Viviani, J.-L. (2015), who conducted a meta-analysis of 85 studies and 190 experiments of other studies, concluded that there was no compelling evidence that various “sustainable and responsible” investing methodologies drove return performance in either a positive or negative direction relative to nonrestricted peers. A few specific examples of these studies include: Goldreyer and Diltz 1999; Statman 2000; Bauer et al. 2005; Bello 2005; Benson et al. 2006.

These studies have been done for investment products labeled “socially responsible,” which includes “biblically responsible” investments as a subset, and counter the fear that a portfolio that restricts its investable universe will automatically have lower returns. The empirical data shows that performance is not hindered by “sustainable and
responsible” investing methodologies, including BRI.

Question #2: Are there enough BRI options to build a good portfolio?

While it is easy to convince a Christian that owning a company that violates Biblical conviction threatens their integrity and sense of Biblical stewardship, it is less easy providing the appropriate bridge to a BRI solution. Are there enough BRI solutions for investors to invest prudently? While there are certainly more “non-BRI” solutions than BRI solutions, there are sufficient options in the marketplace for an investor to create a well-diversified BRI portfolio.

New BRI investment options are becoming more prolific as part of the overall trend toward responsible investing. As the graph on the next page illustrates, sustainable and responsible investing in the United States is growing
exponentially, rising 76 percent between 2012 and 2014 to represent a total of $6.57 trillion of investment capital. This trend is expected to continue in the years ahead, which will help build the supply of BRI products and services available to Christian investors.

However, as the supply of BRI products have grown, the risk of buying a BRI product that is not actually Biblically responsible has gone up as well. For that reason, a “Certified BRI” standard has begun to be developed but it is still in the nascent stages. As such there is still a need for investors to do their homework to make sure the funds they are considering for investment actually do live up to the BRI label.

This can be accomplished by using BRI screening technology that will provide investors a “moral audit” report on their investments, detailing the violations present in the investment being screened. At least one firm, Christian Wealth Management, offers this service free of charge to investors at www.christianwealthmanagement.com.

That said, while there are a significant amount of BRI products available to investors in the open marketplace, there are very few situations where a BRI product is made available to investors housed in their company’s 401(k) or 403(b) retirement accounts. A company’s 401(k) or 403(b) retirement offering tends to have limited investment options. For most employees in a retirement program with their employer, they can only choose from one of a
few possible mutual funds, which are likely not BRI products. There are two possible solutions to this problem for an employee seeking BRI options: divest or engage. The first solution, divesting, would involve an investor liquidating all of their company’s retirement assets and going outside of their company to invest in BRI products. While this is a viable solution, it is not an ideal solution; tax deductibility and company matching for all employee contributions would be lost given this solution.

What about employers, and Christian employers in particular? How can they respond to the requests of their employees for BRI retirement plan options, and more importantly, fulfill their stewardship of God’s resources in their company retirement plan? Thankfully, along with the boom in the BRI trend, new options are opening for employers desiring to implement BRI in their retirement plans, along with others which have been available for some time. For instance, Timothy Plan mutual fund company (www.timothyplan.com), has been providing their funds inside of 401(k)s and 403(b)s since the 1990’s. In fact, the company itself was founded originally to meet the need for biblically responsible retirement plans for pastors. 

A relatively new solution is being provided by Inspire (www.inspireinvesting.com), which has pioneered low
cost, index based BRI portfolios. Inspire delivers a turn-key, low cost retirement plan solution to employers both large and small, leveraging the latest technology to bring a broad variety of indexes and strategies into the retirement plan market, as well as endowment management and individual investors.

Concluding Thoughts

Employees “engaging” employers is an alternative solution to the lack of BRI investment products. This would mean employees voicing an opinion that there is a need for BRI investment options within their investment choices. The current investment options that are available to employees are the result of previous investors requesting a change.

For example, over the last 20 years, employees, through their active engagement, have expanded the current options available in most retirement accounts from large, actively managed U.S. stock funds, to a wide variety of small and large domestic and international funds that are both actively and passively managed. This engagement has also resulted in the widespread adoption of “socially responsible” funds, such as those focused on helping
the environment. With effective engagement, biblically responsible funds can also find their place in 401(k)s on a massive scale.

By “engaging” their employers, a Christian employee can maintain integrity and uphold biblical stewardship, even with owning controversial companies, with the hope that they will improve the current system. However, once engagement proves to be fruitless, the former, divestment option, is likely the next best solution for a Christian of strong moral conviction.