From the global health crisis that claimed millions of lives worldwide to racial injustice protests following George Floyd's murder by police, the past year has forced communities across the country and around the globe to reckon with their vulnerabilities and inequalities. Many investors are now taking a harder look at how the companies in their portfolios are impacting others. There's new interest in investments that create positive environmental, social and governance (ESG) impact, particularly in the social sphere.
The social component of ESG asks how a company's practices affect its employees, customers, investors and local community, as well as society at large. Does it foster a diverse workforce? Does it use suppliers who promote human rights? Does it give back to its community? This also poses a challenge for advisors and investors: How to best identify such companies?
We spoke with James Katz, founder and CEO of Humankind Investments, a quantitatively driven investment manager focused on socially responsible investments that positively impact humankind. The company's Humankind U.S. Stock ETF (ticker: HKND) aims to help investors create positive human impact through their portfolios. Katz shares his perspective on ESG and how investors can decipher ESG ratings as well as the methodology behind the HKND ESG exchange-traded fund. Here are edited excerpts from that interview.
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How do investors cut through the marketing noise in regards to ESG labels?
If an investment manager has lots of different ESG and non-ESG offerings, I think that's a red flag. To me, it means that they don't really care about social responsibility. It's just one of many flavors of investing for them, and they are likely not going to make the costly investment into their ESG research to get it right. But if an investment manager has social responsibility in its core mission, in its DNA, then I think that investment manager is more likely to dedicate resources to doing the deep research necessary to do socially responsible investing properly.
[READ: Q&A: How to Build Better Portfolios With ESG ETFs.]
Ratings firms like MSCI and Sustainalytics purport to rate the quality of ESG companies and investments. What are the pitfalls of such rating systems and how can they be improved?
The ESG ratings system is kind of a hodgepodge of different environmental, social and governance issues. As a result, it struggles to compare their relative importance. Is the environmental component more important, or is the social element more important? To give a specific example, most ESG ratings systems can't seem to make comparisons across sectors. How do you decide how many cigarettes smoked equals 1 ton of carbon emitted?
I think the path to a proper corporate social responsibility ratings system starts with the basic principle of valuing human life, then assessing how much each company is contributing to human suffering, or conversely, human flourishing. If we can put everything into concrete units of human suffering or benefit, we can make different societal issues comparable, figure out what the impact of each issue is and begin to work to invest in the manner that is best for humanity.
For example, according to the World Health Organization, hundreds of thousands of people die each year as a result of wars around the world, but approximately 4 million people die annually from ambient — or outdoor — air pollution globally. So while both issues have their activists, and of course both are terrible, ambient air pollution seems to currently be causing much more of a negative impact on humanity.
We therefore work to reflect the difference in the size of the human impact of these two issues in our investment model. While companies that we see as contributing to war deaths certainly don't get a free pass in our model, companies that our research suggests are contributing to air pollution take even more of a hit. Of course, these numbers change all the time, so we work hard to keep track.
Tell me about your ETF and the core thesis?
We work to estimate how much value each company is creating or destroying for humanity by quantifying and adding up what companies do for investors, customers, employees and society. This results in what we call a company's "humankind value."
We also work to take into account the humankind value of each company's subsidiaries and supply chain partners. We then weight the U.S.-based companies in our proprietary index, the Humankind U.S. Equity Index, primarily based on their humankind values, with companies that create more value for humanity, according to our research, getting a higher weighting in the index. This is the index that our new ETF, the Humankind U.S. Stock ETF tracks.
[READ: Q&A: An ETF for Investors With FOMO.]
What are you doing differently than other asset managers?
Other asset managers struggle with figuring out which issues of social responsibility are important, so they tend to leave those questions to the client. When clients are asked by these managers what issues they care about, there's an assumption that clients have done all the research into figuring out which issues are important and impactful. But in reality, we believe most clients just don't have the time to go down these rabbit holes on their own.
So at Humankind Investments, we try to do this work and quantify impact on behalf of the client, so they can rest easy knowing we're keeping tabs on what will impact humanity instead of passing the buck. We then take what we've learned and invest more in companies that we estimate are creating more value for humanity. We work to both proxy vote in a socially responsible manner and also directly engage companies to let them know how they can improve their standing in our index. We also work to leverage the power of our clients' ownership and vote the shares on behalf of our clients in a socially responsible manner. In doing all this, we hope to significantly improve how companies impact humanity.
With the HKND ETF still so new, how does being thinly traded impact liquidity for current investors?
There is, theoretically, an unlimited number of shares that authorized participants, or brokers who can trade directly with HKND to create new shares to sell on the open market, can create if there is enough demand for new shares from regular investors.
So just because an ETF is thinly traded doesn't mean that there isn't sufficient liquidity for an investor to trade a large order in or out of that ETF.