‘Social Alpha’: Nonprofits Dive Into ETFs

January 04, 2018

Ethan PowellEthan Powell is a man on a mission.

As CEO of Impact Shares, the first nonprofit ETF issuer, Powell wants to modernize the way charities—and donors—think about using money to make a difference.

"ETFs are almost the perfect engagement vehicle for nonprofits," he said. "We can use ETFs to bridge capital to cause."

In late November, the firm announced partnerships with two prominent charities, the National Association for the Advancement of Colored People (NAACP) and the YWCA Metropolitan Chicago, to bring single-issue socially responsible ETFs to market.

Neither fund has been approved by the SEC yet, but a Q1 2018 launch is expected. And Powell has more ETFs in the works, with both the American Cancer Society and the American Heart Association in talks to launch funds through Impact Shares.

His end goal is to have every social issue—from arts education to veterans affairs—represented by a separately investable ETF, allowing investors to "create a sophisticated, bespoke, socially responsible portfolio to reflect your individual priorities."

Fixing ESG's ‘Messy Middle’

ESG—or "environmental, social and governance"—investing is a catchall term that becomes less useful the harder one looks at it.

Arguably, it's easy to quantify what makes a company environmentally friendly (e.g., a low-carbon footprint). Good corporate governance is more nebulous, but often it's defined in terms of rules concerning ethics, equality and transparency.

But measuring a company's overall positive social impact is much harder. What one person believes is in the social good may not matter at all to another person—or, worse, the two may be in direct conflict.

Generally, socially responsible ETF issuers have dealt with this problem in one of three ways.

  • Excluding "sin stocks" whose businesses most people agree have negative societal impact (e.g., tobacco producers, firearms manufacturers, gambling stocks). Unfortunately, this workaround doesn't really address or define what "socially responsible" is, only what it isn't.
  • Ignoring the "social" category altogether and instead focusing on a company's environmental or governance vectors, with the understanding that what's good for the environment or the labor force also tends to be good for society.
  • Devising a proprietary system to rank and score stocks according to social metrics. However, as Powell points out, this method means the profit-driven asset manager "becomes the arbiter of good citizenship."

Impact Shares uses the third approach, but takes it one step further. To develop meaningful evaluation metrics, Powell directly partners with charities that are leading their particular social cause. Case in point: the NAACP on the cause of minority rights.

"We're leveraging the hundreds of years of experience these organizations have to design superior social metrics based on their understanding of the issue." (The NAACP did not reply to requests for comment in time for publication.)

Giving Back The Advisory Fee

In practice, Impact Shares will operate much like a typical white-label ETF provider: The firm will take care of the day-to-day investment management on behalf of its partner charities, while also charging them an annual fee for service.

The big difference, however, is that Impact Shares is itself a tax-exempt nonprofit 501(c)(3) organization. As such, it donates 100% of its advisory fee back to the partner charity, less operating expenses and working capital.

Partner charities can then use that money as they see fit, directing it into their own programs, or regifting it to charitable causes that support its mission.

"It's a charitable giveback they can use as they see fit," said Powell.

Donated Advisory Fee Scenario

Powell estimates that the donated advisory fee will amount to roughly $500,000 per $100 million of assets under management. That's not much, especially considering that over half of ETFs on the market—53%—fall well below the $100 million mark.

But Dorri McWhorter, CEO of YWCA Metropolitan Chicago, isn't bothered: "For us, it's really no different than any other cause-marketing relationship we have," she said. "It's about leveraging all parts of a market that can actually advance one's work."

An ETF doesn't cannibalize potential charitable donations, she says; instead, it funnels existing investment dollars toward charitable goals. "People are going to invest their money anyway. But this way, they can invest as well as contribute to us. It's not necessarily an either/or," McWhorter noted.

 

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