November 12, 2003
Innovest’s Eco-Enhanced Portfolios Outperform Their Benchmarks
by William Baue and Mark Thomsen
Contra Costa County Employees’ Retirement Association achieves both actual and simulated
out-performance by tilting its portfolios using Innovest’s EcoValue21 ratings.
How does the application of sustainable and responsible investing (SRI) considerations affect the
financial performance of portfolios? While many institutional investors ponder this question,
relatively few have taken substantive steps to answer it through actual SRI investment, or through
tracking the performance of hypothetical SRI portfolios. Last year, however, the Contra Costa County Employees’
Retirement Association (CCCERA) contracted Innovest Strategic Value Advisors to do both.
“CCCERA’s mandate was double barreled,” said Matthew Kiernan, founder
and CEO of Innovest, a research firm that evaluates the environmental and social performance of
over 1,200 publicly traded companies. Innovest compares these globally traded companies’
environmental and social performances to their financial performances.
directive was to work with Aeltus, an ING
subsidiary, to construct and run real money in an eco-enhanced S&P 500 index portfolio combining
Aeltus’ alpha strategies with our own, with the hope that two cracks at out-performance are
better than one,” Dr. Kiernan told SocialFunds.com. “We prefer to leverage our
partner’s expertise, so we integrated our algorithms directly into their model.”
Innovest’s proprietary EcoValue21 (EV21) environmental ratings account for approximately
20 percent of the weighting in the investment algorithm of this portfolio, which launched in March
2002 with $150 million.
“The eco-enhanced index fund is out-performing its S&P 500
benchmark by an annualized 15 basis points--not huge out-performance, but a lot better than
under-performance!” said Dr. Kiernan.
“Perhaps even more interesting,
Contra Costa also asked us to do a live simulation of the impact of adding an Innovest
‘tilt’ to the rest of their outside managers’ portfolios,” added Dr.
Kiernan. “This provides an even ‘purer’ test, because the only factor
added to the underlying portfolio was the Innovest overlay.”
external managers provided Innovest with the actual holdings in their portfolios as of December 31,
2001. Innovest applied its EV21 ratings to create simulated portfolios that ‘shadow’
the performance of the actual portfolios in real time, instead of back testing. Innovest
rebalanced its tilts on a quarterly basis according to the managers’ rebalancing of their
holdings throughout 2002.
“We overweighted the companies we had given high EV21
ratings to and underweighted companies that got low ratings,” said Hewson Baltzell,
Innovest’s president. “We used a portfolio optimization model, which is something
quantitative money managers use all the time.”
“Then we turned up the volume
of our signal, the so-called ‘tracking error,’” Mr. Baltzell told
Innovest cranked up the volume (or the “tilt” or the
“tracking error”) by 50 basis points, 100 basis points, and 200 basis points for all
six portfolios, thus creating 18 shadow portfolios. The actual portfolios covered diverse
allocations: U.S. large cap growth, U.S. large cap value, international large cap, U.S. mid and
small cap core, U.S. enhanced index, and U.S. large cap core.
“In five out of six
cases, it helped to increase the volume,” said Mr. Baltzell.
For example, the U.S.
mid and small cap core portfolio outperformed the actual portfolio upon which it was based by 51
basis points with the mildest volume increase, by 92 basis points with the middle tilt, and by 158
basis points with the strongest signal. The one underperforming shadow portfolio, the U.S.
enhanced index, lagged its benchmark portfolio by 1 basis point, 4 basis points, and 40 basis
points with the respective tilts. The average out-performance was 20 basis points for the mildest
volume increase, 43 basis points for the middle tilt, and 82 basis points for the strongest signal.
“The bottom line is that five out of the six portfolios would have added
performance, so we were able to go back to the county and say that it essentially left some money
on the table last year,” concluded Dr. Kiernan.