How to Create An Impact Portfolio Quantitatively in 2021

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An individual’s investment portfolio can be their single largest carbon footprint. Optimizing your portfolio to reduce this carbon footprint should be at the forefront of your mind.

Impact investing is an investment strategy that seeks to generate financial returns while also creating a positive social or environmental impact. It helps alleviate poverty, eliminate hunger, achieve sustainable development, improve access to excellent healthcare and education, achieve gender equality, assure justice, and promote peace. Impact investing helps build a better future, usually targeting one or more issues from the UN’s sustainable development goals.

Investing conscientiously does not have to be at the loss of your investment returns – more than 88% of impact investors reported that their investments met or exceeded their expectations, according to GIIN. Today I’m going to discuss the 4 steps needed to build a quantitative impact investing portfolio, targeting the issues that matter most to you, so you can grow your money with a clean conscious and help make the world a better place. The techniques found in this article are not found anywhere else on the web, so welcome to the exclusive conscientious quant club!

4 Steps to Create a Quantitative Impact Investing Portfolio

Step #1: Define your goals and objectives

Simply put, this is discovering what impact you want to have with your investments – what matters most to you. The process of developing an impact portfolio requires a review of your expectations and objectives in terms of generating social and environmental effects. However, the right answer regarding a portfolio’s intended impact differs from one investor to another.

For example, an investor passionate about climate change mitigation may find it hard to invest in fossil fuel production. In contrast, another investor passionate about sanitation and hygiene will be comfortable investing in the achievement of the Sustainable Development Goal 6 on water and sanitation.

You can better understand your values by discussing your investment strategy with your peers and journalling about what matters most to you. The goal is to develop a plan that best advances toward your goal.

Don’t wait for others to bring up the idea of impact investing; you need to initiate the conversation yourself. Discussing the UN’s sustainability goals also leads to a very stimulating conversation!

Find out what impact options might work best with your risk tolerance.

Having a basic understanding of the terminology used to describe such investments will help you decide your goal.

Step #2. Design Your Investing Thesis – Decide Which Impact Metrics to Use

An investment thesis is a written document that puts structure, systems, and guidelines in place on which companies to invest in. The use of an investment thesis can help the investor filter and screen companies so that they can identify the most optimal investments for a given set of preferences and particular targets. We have a complete article here on how to create an investment thesis.

It is crucial to invest quantitatively if you want to purposefully incorporate impact across your whole portfolio. Ad hoc impact investing or divestment is not a long-term impact strategy.

Building a quantitative impact investing portfolio is a 9 step process:

  1. Determine your amount to invest
  2. Choose your Market(s)
  3. Choose you Industries
  4. Choose you Market Capitalization (What size of companies go into the portfolio)
  5. Apply Impact Filters
  6. Apply Fundamental Filters
  7. Apply Technical Filters
  8. Rank and Select the Stocks
  9. Determine Portfolio Rebalancing & Monthly Contributions

Usually you can do all of this filtering with a stock screener like Finviz, or you can get pre-built strategies from Aikido finance.

Sample Investing Thesis

This year, I will be implementing The Stable Dividend strategy. I will be investing $5000 in US large-cap stocks. These stocks must have a dividend yield greater than 2.5% and a payout ratio of less than 50%. I will then pick the top 20 stocks based on those with the highest debt-to-equity and ROIC. I will apply an eco filter, to filter out the most highly-polluting industries. I will rebalance the portfolio monthly and invest an additional $500 each month. This strategy has averaged a return of 11.75% over the past 20 years in backtests.

What Impact Investing Techniques Can You Use?

1. Filter out polluting industries from your screen

Here are some industries you could consider removing from your screen based on their high carbon emissions:

  • Food Meat Fish Dairy
  • Integrated Oil
  • Chemicals Agriculture
  • Airlines
  • Other Transportation
  • Oil Gas Pipelines
  • Oil Gas Production
  • Oilfield Services Equipment
  • Coal
  • Forest Products
  • Fashion

Aikido simply offers a single “Eco” portfolio addon to do this for you.

2. Conversely, Filter For Only Specific Industries

Water, Forestry, Clean energy, education

3. Filter out specific countries from your screen

There are certain countries around the globe that are extremely unethical and/or poluting, you may want to remove them from your portfolio.

4. Review every company before it goes into your portfolio

By the end of the 9-step process laid out before, you will have a portfolio of 20 or so companies. You should review each of the companies that remain to ensure that they are the right fit for your portfolio – did any unethical or unsustainable companies slip through?

5. Use the Beneish M score to determine if a company has been manipulating earnings

The Beneish M Score of a company can be found easily online, for example on Gurufocus. You will want to filter out companies with high Beneish M Scores (> -1.78) as it is an indicator of shady/untruthful management.

6. Search for Specific Management

Black focussed and Female focussed investment portfolios are becoming ever more popular as the world endeavours to become a more equal place. These filters can be hard to apply during the screening process, but can easily be found on each company at the end of the screening process with websites like Yahoo Finance. Aikido Finance will be offering these addons in the future.

7. Only purchase Companies With High ESG Scores

This is the best technique you can use to create a quantitative impact investing portfolio. ESG stands for “Environmental, Social, and Governance.” It is a series of scores given to publicly traded companies by independent auditors.

Some of the non-traditional metrics ESG investors may consider include:

  • Environmental: Carbon and green-house-gas emission; water pollution; resource usage efficiency
  • Social: Employee motivation and corporate culture; customer, and community sentiments towards the corporation; gender and racial equality
  • Governance: Sensible executive pay policies; effective and experienced corporate boards; proper accounting and reporting procedures.

Currently, it is difficult to filter/screen for companies using ESG metrics. But you can still review each company before it goes into your portfolio to ensure it has high ESG scores. A company’s ESG scores can be found on Yahoo Finance. Below is Apple’s (AAPL) ESG scoring.

Step #3. Create Your Portfolio

Pick a low-cost online broker and purchase the 20 or so companies you chose from the 9-step screening process laid out above. We suggest using Interactive Brokers as they are low cost and integrate well with Aikido Finance.

Step #4. Monitoring and evaluation

Continuous monitoring and review is a best practice for any portfolio, especially for intentionally designed to have a good impact. Remember that the investment thesis is a living document that should be evaluated at least once a year, with its assumptions re-affirmed or adjusted based on various circumstances.

Financial and impact performance benchmarks should be set per the investment strategy. Reviewing portfolio performance against these benchmarks regularly will reveal any needed adjustments to the investment strategy.

Be sure to rebalance your portfolio per the rebalance period (eg. One month) and to stick to your investment thesis! Never stray from your investment thesis, stay quantitative.

Final Thoughts

Impact investing is an excellent way to drive systemic change in the way global financial markets operate – It serves the real needs in society and the real economy.

In the 2020 Annual Impact Investing Survey, GIIN estimates the current impact investing market size at USD 715 billion. Impact investing is no longer an alternative way to invest; it is THE way to invest.

There are more opportunities than ever before to make impactful investments, so now is the best time to start. Start investing conscientiously.

If you want to start quantitative impact investing, you can create a portfolio completely for free on Aikido Finance. We make it super fast and easy to create a rules-based investment portfolio.

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