The Institute for Innovation Development interview series seeks to learn from innovative business leaders, uncover innovation best practices, and discover how to apply these insights into the financial services industry.

We recently sat down with Matthew Blume, CFA, portfolio manager and manager of shareholder activism at Pekin Singer Strauss Asset Management -- an independent wealth management firm and advisor to the  Appleseed Fund (APPLX, APPIX) – to learn about their views on business innovation, ESG screens and how they apply them to their socially responsible investment process in their mutual fund.

Hortz: Why do you claim that adding environmental, social and governance screens can further reduce investment risks in your clients’ portfolios?

Blume: Companies that fail to address their environmental, social and governance impacts face substantial legal and regulatory risks, in our estimation.  When a company focuses on improving its safety performance, it reduces the risk of a safety-related lawsuit. When a management team is already looking to improve its own environmental performance, the likelihood of a large environmental-related liability is diminished. When management incentives are properly aligned with shareholders, managers are less likely to risk a company's competitive positioning for a short-term gain of the stock price.

But beyond that, they also risk their reputations and their social license to operate.  These can be existential risks.  Management teams that focus on operating their businesses in sustainable ways that are friendly to shareholders and other stakeholders tend to have a long-term focus.  As long-term investors, this is who we are looking to align ourselves with.  We believe that investing in companies that take a comprehensive and long-term-oriented view of their business will expose our portfolios to less risk of permanent capital loss.

Hortz: Environmental issues are easy enough to understand, but tell us more about what you look for in your social screens?

Blume: We use positive and negative screens in our security selection.  We apply several negative screens in order to simply eliminate certain types of companies that we believe introduce high levels of risk due to the industries in which they operate.  Initially we screen out companies that earn a material proportion of their revenues from alcohol, tobacco, gambling or weapons. In addition, we avoid investment in fossil fuel companies or too-big-to-fail banks. We believe that these types of businesses materially increase the risk of our portfolios because of potential social, environmental, legal or safety issues. These businesses also face substantial reputational risk.  Beyond this initial screening, we also look for positive social attributes that make companies more attractive. We search for companies whose products or services make a positive social or environmental impact and that should benefit financially as a result.  For example, one of our largest holdings is United Natural Foods (UNFI), a natural foods distributor that is an essential part of the supply chain that provides healthy nutrition to consumers.  We expect the company will benefit considerably over time from the long-term trend toward healthier consumer food choices in the U.S.

Hortz: How exactly do you analyze a company for governance? What do you look for?

Blume:  There are several factors that we examine.  We are looking for management teams that have a long-term focus, that are shareholder friendly, that have “skin in the game,” and that have adopted best-in-class governance practices.  With respect to shareholder friendliness, we look at whether cash is returned to shareholders through dividends and buybacks versus making value-destroying acquisitions or management paying themselves exorbitant bonuses. We look at how management responds to shareholder proposals and otherwise engages with shareholders. When we talk about having “skin in the game,” we are referring to having a material financial stake in the long-term success of the company.  We believe that it is very important for managers to own meaningful stakes in the companies that they lead, so we look at insider ownership and transactions.  And then we look for sound governance practices, such as separation of CEO and Chairman, an appropriate level of board diversity, and prudent and aligned compensation structures for management.

Hortz: Part of your process is determining responsible management teams that place “an intense focus on delivering long term value.” How hard is it to find these companies with so much of corporate America focused on next quarter’s earnings and analyst expectations?

Blume: It is a challenge to be sure, and we don’t always get it right, just as our investment thesis does not always play out the way that we expect.  But we can learn a lot from a management team’s past actions. Our research process looks at how management teams behave with respect to a number of factors: compensation, leverage, capital stewardship, sustainability reporting, shareholder engagement, etc.  We look at all of these things and more to get a sense of how focused management is on creating long-term value for shareholders.  And while our analysis will not always be perfect, we believe that if we adhere to our fundamental values and maintain our discipline in analyzing and selecting companies to invest in, our investors will be well-rewarded over the long term. 

Hortz: Does a company’s innovation activities play into your analysis and responsibility screens?

Blume: Definitely. Innovation is a broad term, and it can be used in a number of contexts.  If we’re looking at a technology company, then we want to have some confidence that management has created a culture that fosters innovative technological development so that the company will remain relevant and competitive going forward.  This kind of consistent innovation requires a culture that encourages creativity and rewards forward-thinking.  And while many industries do not rely so much on technological innovation, companies of all types can benefit from this type of innovative culture. This is the kind of forward-looking culture that we try to identify in our analysis of potential investments, whether it is in the context of technology or sustainability or simply business strategy. Innovative culture can be difficult to identify, but it can be a key driver in business success.

Hortz: Do you factor in an innovation premium for companies in your overall company valuation and ultimately in the companies you pick for your client portfolios?

Blume: There is no doubt that we favor companies that have displayed a consistent ability to innovate and stay ahead of their competition, in terms of technology, business practices, sustainability, and marketing.  Companies who we believe can continue to innovate well over time should grow revenues more quickly and also maintain higher profit margins, all other things being equal, and that would factor into our valuation.

Hortz: Your research has found that a lot of successful company managements use business innovation practices. Do you feel that these practices would benefit financial advisor businesses?

Blume: I believe that any business can benefit from a culture of innovation and a long-term focus. Obviously this manifests itself differently depending on industry, business size, etc., but generally speaking, having a future orientation is good for any type of business, including financial advisory businesses. 

Hortz: Speaking of governance, what exactly is a B corporation and why did you structure your company as a B Corp?

Blume: Well, a B Corp is a for-profit company that is certified by the non-profit B Lab to meet rigorous standards of social and environmental performance, accountability and transparency. These are companies that wish to benefit society as well as their shareholders.

We made the decision to become a B Corp because we saw it as a way to outwardly reflect the culture and philosophy that our firm has embodied since it was started more than 25 years ago.  In addition, we saw the very rigorous certification process as a way to push the firm to perform at a higher level.

Hortz: Do you feel that more financial services firms should consider becoming B corps?

Blume: Absolutely.  Businesses of all types in all industries could benefit from becoming B Corps. The B Corp assessment is very rigorous, and it challenges business owners to look at their businesses in new ways.  It also encourages owners and managers to institutionalize positive practices or methods. Oftentimes, businesses will be doing something well simply because it makes good business sense, but the B Corp assessment encourages businesses to take those good everyday practices and build on them in ways that improve companies, both internally and in their effect on their communities.

Hortz: From your experience, what is your best advice to advisors about building a portfolio for their clients looking to use values-based investment principles?

Blume: The first and most important thing that advisors can do is simply have conversations with their clients to understand each client’s unique values. This understanding is the foundation upon which a values-based investment portfolio is built.  Oftentimes, advisors are not even aware that their clients may have an interest in building a values-based investment portfolio and therefore miss an opportunity to provide a greater level of service to their clients. Surveys have indicated that simply having a conversation about a client’s personal values and how those values can be integrated into an investment portfolio can strengthen the client/advisor relationship.  And then if there is interest on the client’s part in building a values-based investment portfolio, I would recommend advisors familiarize themselves with some of the ESG-focused investment managers in the marketplace who have expertise in managing these types of portfolios.

The Institute for Innovation Development is an educational and business development catalyst for growth-oriented financial advisors and financial services firms determined to lead their businesses in an operating environment of accelerating business and cultural change. We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation and unique community engagement strategies. The institute was launched with the support and foresight of our founding sponsors: Pershing, Voya Financial, Ultimus Fund Solutions, Fidelity, and Charter Financial Publishing (publisher of Financial Advisor and Private Wealth magazines).