By Ellie Winninghoff
Customer satisfaction, employee access to health care, and carbon emissions per unit of revenue aren't the sorts of metrics you find in a company's financial statements. But they represent non-financial impacts companies create. And they are among the 30 or so environmental, social and governance indicators that HIP Investor Inc. says can lead to higher profits.
"These are not ethical values but leading indicators of performance," says Paul Herman, CEO of HIP, which stands for Human Impact + Profit. The San Francisco-based registered investment advisor and asset manager employs a multi-disciplinary approach that marries finances with sustainability. Among other things, the company offers separately-managed accounts for client portfolios and has developed a handful of investment indexes based on its sustainability ethos.
That includes its HIP 100 portfolio that uses the company's proprietary sustainability criteria to re-weight the S&P 100 index, which is based on market capitalization.
"You own more of the leading sustainability companies and less of the laggards," Herman says. "This allows you to be more diversified [than if you invest in a traditional SRI fund.]"
In terms of how companies are weighted, the difference between the S&P 100 and the HIP 100 can be significant. The HIP 100's top three holdings are Intel, Hewlett-Packard and Cisco Systems, which are numbers 17, 42 and 23 in S&P's index, respectively. They account for 4.8% in the HIP portfolio versus 3.9% in the S&P index.
In contrast, the top three firms in S&P's index are Exxon, Apple and IBM, which rank as numbers 28, 37 and 11 in HIP's portfolio. They account for 13.5% of S&P's capitalization versus just 3.73% of HIP's portfolio.
Since inception on July 30, 2009, the HIP 100 return as of Dec. 31, 2011 was 32.5% compared to 29.7% for its benchmark S&P iShares ETF.
Now HIP has applied its sustainability scoring system to preferred stocks and real estate investment trusts. In December, it introduced HIP Preferred, a portfolio of 60 preferred stocks yielding 5.75%. And the HIP Sustainable Real Estate, a portfolio consisting of 45 securities expected to yield 4.2%, will go live in this year's first quarter.
While HIP's weighting of common stocks since inception has outperformed the S&P 100, the firm's performance was weakest last year. Herman attributes this at least in part to an overweighting of banks, which he notes were taking customer deposits and using them to take investment banking risks. "A lot of banks have systemic risk due to the way they're operating," he says, "and they are not treating the customer in a HIP way."
Financials, of course, account for more than half the preferred market. And while preferred stocks are generally less volatile than equities, this was not the case in either 2008 or 2011, when Herman says preferred stocks in the financial sector behaved like equity.
As a result, the HIP Preferred portfolio consists of the available universe of preferred stocks listed in the U.S. sans most financials. The firm applies the same methodology it uses for the HIP 100, adjusted for risk-rated return. The portfolio, which consists of 60 different securities, is 20% global and the rest US-based companies. Top holdings are First SpA, Bristol-Myers Squibb and DuPont, which account for 5.27%, 4.04% and 3.27% of the portfolio, respectively.
The HIP Sustainable Real Estate portfolio, on the other hand, focuses more on environmental sustainability. According to Herman, only 50 of 200 REITs provide sustainability data. To assess them, the firm also uses LEED certification and Energy Star data that shows how eco-efficient different buildings are. And it applies a heavier weight to those REITs that are managing forests and other natural resources more sustainably and which are transparent. Top holdings include Weyerhauser, Prologis, UDR,and Rayonier.
Thanks to factors like reducing energy costs, water consumption and waste, Herman says it's "pretty crystal clear" that sustainability has a high return on investment in commercial real estate. "I've talked to no less than three REITs or real estate management companies that said they could not share information because they consider it a competitive advantage."
Maslow's Hierarchy of Needs
Herman insists that investors can actually profit by doing good. In his book, The HIP Investor: Make Bigger Profits by Building a Better World (Wiley, 2010), he points out that companies are often so fixated on their financial and operating ratios that they become "disconnected" from the "true source" of a company's growth, which is finding solutions to customer needs.
But if this sounds like Business 101, hang on. According to Herman, a Wharton grad who cut his teeth at McKinsey & Co. and later worked with eBay founder Pierre Omidyar's Network, many benefits of solving those needs can be quantified. Consider, for example, longer life from a medical device, more income from a savings account or lower fuel use (and carbon emissions) from a hybrid car.