Is Values-Based Investing Right for Your Organization?

Many organizations want to align operations with their values, but how do they decide if they should align their investments with those values?

By Joe Guest, CIMA®

ESG Investing

Values-based investing has gained significant traction in recent years, and with its increase in popularity, many organizations are deciding whether to incorporate nonfinancial factors into their investment decisions. Many organizations want to align operations with their values, but how do they decide if they should align their investments with those values?

This article introduces a systematic approach that aims to aid in the consensus-building process while exploring certain trade-offs and potential implementation choices. Here are the steps we suggest if you are contemplating values-based investing:

  1. Clearly define the organization’s values.
  2. Gain consensus on whether those values should be factored into investment decisions.
  3. Fully understanding the trade-offs involved.
  4. Know the investment options available.
  5. Document the process and update the investment policy.

To successfully implement a values-based approach, there needs to be a consensus around the organization’s values. However, achieving consensus within an organization can be a difficult process. Without well-defined values, it becomes challenging to make informed decisions about investments that align with these principles.  In the absence of well-defined values, we would advise against values-based investing.

Define Values

The first and most critical step toward values-based investing is clearly defining your organization’s values. These values serve as the guiding principles that shape the organization’s ethical and social framework. We recommend starting with an assessment to ensure values are clear and collectively understood. If clarification is needed, key stakeholders should be involved in a process to establish a shared understanding of the organization’s values.

Some organizations may find their values more easily align with available investment options than others. For example, an organization committed to sustainability would likely desire to use a sustainability-focused investment.  However, organizations with broader or more general values might face challenges in aligning their investments with their values.

Gain Consensus

After values are defined, the next step is gaining consensus on if those values should factor into investment decisions. Not all organizations will find values-based investing a good fit. A high-level survey can provide a valuable opportunity for board members to anonymously share their perceptions of the organization’s values and whether they should be reflected in the organization’s investments. Ensuring everyone is on the same page will help the organization remain disciplined to the values-based approach.

Get comfortable with the Trade-offs

The next step involves all key stakeholders gaining a comfort level with the trade-offs associated with values-based investing. This pivotal step will empower the organization to understand all involved costs and maintain discipline, especially when performance diverges from the benchmark.

One key consideration is tracking error, which measures how much an investment’s future return potential may differ from its benchmark. Values-based investing can involve promoting or restricting investment in certain companies or market sectors, resulting in short-term performance differences from the benchmark.

Organizations considering values-based investing must assess whether their board or finance committee is comfortable with varying levels of tracking error.  Investing effort in the initial alignment of values with investments can help increase tolerance for tracking error. While short-term deviations are expected, over the long term, performance should align more closely with the market.

What to Look For: Tracking Errors

Be prepared for periods of tracking error; for example, a values-based U.S. equity fund underperformed the total U.S. stock market by over 3.5% in the first half of 2023. The fund’s underperformance was attributed to the exclusion of a few mega-cap technology companies due to labor or privacy concerns. Those companies contributed to most of the the market’s gains during the period. Understanding and accepting tracking error is crucial for success, as abandoning the approach at an inopportune time could result in losses.

Fees are another consideration when adopting a values-based approach. Values-based investments consider both financial and nonfinancial criteria when making investment decisions. Managing a values-based fund requires extra effort and research, which adds to the cost. Although fees have decreased in the last decade, values-based investments are still pricier than equivalent non-values-based options. Confirm the organization is willing to allocate additional resources for this endeavor.

Available options

After clarifying corporate values and understanding the trade-offs, the next step is to identify how to implement the values-based approach. Organizations have two primary options for values-based investing.

One approach is to adopt investments that apply broadly defined ESG standards. These investments are typically cost-effective, easy to implement, and offer access to pre-established ESG investment choices. However, this option provides limited control over specific guidelines and exclusions, potentially compromising alignment with unique corporate values.

Another option is to create custom-designed values-based criteria, offering full control in shaping guidelines and restrictions to precisely align with organizational values. Custom design, though, may come at a higher cost and requires additional ongoing oversight and policy maintenance.

Document the process

Once the preferred approach is determined, it’s crucial to document the purpose, objectives, roles, risks, and performance expectations related to values-based investing. This ensures alignment with the organization’s values and financial goals and will enable future stakeholders to fully understand how and why decisions were made to implement a values-based approach. We recommend conducting interviews with key stakeholders and surveying the board to understand and formalize corporate values. Then, draft policies outlining the goal, purpose, objectives, roles, risks, and performance expectations.

In conclusion, the rise of values-based investing has presented organizations with a critical decision: whether or not to integrate nonfinancial factors into their investment decisions. This article has outlined a structured approach to guide organizations in this complex decision-making process. The first step emphasizes the importance of clearly defining organizational values. Understanding the trade-offs associated with values-based investing is the next crucial phase. This includes considerations such as tracking error and fees. Once these considerations are in place, organizations can choose between broadly defined ESG investments or custom-designed solutions to implement their values-based approach. Custom design offers greater control but may come with higher costs and additional ongoing oversight. Documenting the purpose, objectives, roles, risks, and performance expectations related to values-based investing is essential to ensure alignment with organizational values and financial goals. Values-based investing may not be the right fit for every nonprofit organization. I hope this article provides a systematic approach your organization can use in determining its suitability.

1 TIAA-CREF Social Choice Equity fund – 12.53% v. the Russell 3000 index  16.17% (YTD performance as of 6/30/2023)

About the Author

Joe Guest is a Senior Portfolio Manager at Raffa Investment Advisers. Joe serves as the primary contact for many of Raffa’s association clients providing investment recommendations, investment policy support & guidance, Board training & education, and more. To learn more about Joe and Raffa Investment Advisers, please contact us here:

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