Seattle-based SNW Asset Management, an independent RIA that provides active fixed-income portfolio management and has approximately $1.7 billion in assets under management, had to think on its feet last year when some advisors began to push for impact investing-focused bond portfolios.

Part of the problem is that few bond portfolios are packaged or even assessed using impact criteria. In addition, credit ratings from Standard & Poor’s, Moody’s and Fitch Ratings fail to address social and environmental impacts that could affect future financial performance. For example, AA or A-rated bonds issued to a coal-burning power plant might not price in the risks of pollution or negative health outcomes.

But everything clicked when a mutual client introduced SNW Asset Management to HIP Investor Inc., a San Francisco-based firm that rates more than 4,000 companies globally for impact and advises on more than $120 million in assets. Initially, the firms partnered to rate 200 municipal bond issuers. That number has grown to 500 and keeps expanding. In early 2013, they began offering custom impact-rated bond portfolios.

“We dug in last fall and launched in January,” says Eddie Bernhardt, president and CEO of SNW Asset Management. “We saw a big, wide-open space in the market.”

As of August, the SNW HIP-rated bond portfolios totaled $70 million in assets. Eighty percent of that amount comprised tax-free municipal bonds, with the remainder split among government and corporate bonds (7.5 percent each) and taxable municipal bonds (5 percent).

SNW’s credit team, which vets the credit quality of each issue, applies HIP’s impact ratings as part of its fundamental credit analysis. The HIP Scorecard rates issuers on a scale of zero to 100 based on health, wealth, earth, equality and trust factors. The midpoint, 50, signifies a net positive benefit to society, says R. Paul Herman, CEO of HIP Investor.

Issuers are divided into eight broad categories: education; health care; water and waste water utilities; energy utilities; cities, counties and states; transportation, ports and airports; U.S. Treasuries; and agency debt.

“No other provider in fixed income looks at bonds in this depth,” says Herman, who describes it as “quantitative, measurable results with a mission.” Advisors typically ask SNW to select either the highest HIP-rated bonds available; a mix of bonds that average a designated HIP score; or a theme that interests a client such as education, environment, health outcomes or sustainable cities.

SNW does not have a long enough track record of accounts managed in the HIP strategy to have Global Investment Performance Standards compliant composites, says Bernhardt. GIPS is a set of standardized, industry-wide ethical principles that guide investment firms on how to calculate and report their investment results to prospective clients.

“That said, for HIP-rated bond portfolios we currently manage, investors earn roughly the same yields as non-impact rated bond accounts and we expect long-term performance to be very similar as well,” he says.

For example, he notes that one of SNW’s HIP-rated bond accounts is a national intermediate tax-free bond account with a yield of 1.80 percent while SNW’s non-HIP national intermediate tax-free bond composite has a yield of 1.75 percent.

The HIP scorecard can also serve as an early warning system for performance. Using historical data, he and Bernhardt have found that defaulting and at-risk issuers (such as the City of Detroit and the City of Philadelphia, respectively) would have commanded much lower impact scores than other municipal bond issuers even well before their credit troubles surfaced.

HIP also covers all or nearly all of SNW-managed corporate bonds, plus sovereigns (including U.S. Treasuries), agencies (such as Freddie Mac and Fannie Mae) and munis issued by non-profits (including universities and health care systems).

Good Source Of Liquidity

The Caprock Group—a multi-family office located in four western states—has used SNW Asset Management as its core fixed income manager for years and provided a couple of client portfolios for beta testing of SNW’s impact-rated bond portfolios. While only about 15% of the 75 families Caprock works with are impact-oriented, these clients seek impact across their portfolios, says Matthew Weatherley-White, a managing director with Caprock. Impact-related investments account for about $1 billion of Caprock’s $2.2 billion of assets under advisement, he says.

The SNW impact-rated portfolios work well with Caprock’s overall outlook on fixed income. “We don’t see it [fixed income] as a volatility dampener,” Weatherley-White says. “We see it as a source of liquidity that clients may need during periods of adverse market behavior.” 

He likes that the impact-rated bond portfolios don’t require clients to take any additional credit, duration or interest rate risk versus conventional fixed-income portfolios, and there is no need to sacrifice yield for impact. Currently, yields for Caprock’s impact and conventional clients range from 1.75 percent to 2.25 percent depending on when their portfolios were built, he says.

Caprock clients have invested in munis issued by the Port of Seattle, which has a HIP score of 70. The port offers the lowest carbon footprint for cargo sent from Asia to Midwest cities, is increasing power efficiency by ships in port, and is reducing emissions at the Seattle-Tacoma International Airport, Herman says.

Weatherley-White notes that some of his firm’s clients are interested in investing in education issues.

Seattle-based wealth manager Brighton Jones LLC, which has more than $2 billion under management, saw the impact-rated bond product as the perfect solution for a client who came in about a year ago with a particularly strong desire for impact investing, says Matthew Camrud, a lead advisor with the firm.

He anticipates rolling out SNW HIP-rated bonds to more clients as they express interest in adding a socially responsible tilt to their portfolios.

High Impact, Low Cost

The aforementioned client, who is very interested in environmental issues, holds municipal bonds from a number of issuers including Clark Public Utilities of Clark County, Wash. The utility has a HIP score of 74, which Herman attributes to its large hydro power and renewables efforts, high reliability of power and diverse leadership.   

Since Washington State has no state or local income taxes, such exemptions on tax-free munis is not relevant to clients based there. “We can go anywhere,” says Camrud. Brighton Jones has invested assets in impact-rated municipal bonds from such far-flung states as California, New York, Florida, Idaho and Georgia.

His firm looks at clients’ cash-flow needs for the next 10 to 15 years and invests in higher-quality shorter term bonds like those in the impact-rated bond portfolio. “It’s a win-win situation,” he says, “because clients still get good diversity, excellent credit quality, low costs and a degree of social impact.”

At SNW, the firm charges a fee of 30 basis points (0.3% of assets managed) for its impact-rated bond portfolios—just five basis points higher than what it charges for the bond portfolios it manages without HIP ratings.

Bernhardt says a lot of SNW’s investors use a blend of taxable and tax-free bonds. “Now all can be rated with impact,” he says.